There are two strategies I like to employ when using Technical Analysis.
- The first strategy is to identify the phase of the market – as discussed in my book Sideways . Once we identify the phase, we will utilize strategies to trade the market according to whether it is trending, consolidating, or breaking out. I discussed market phases in this blog recently.
- The other strategy is to use forward-looking analysis to predict potential rotations or changes in trend. This is not as straight forward as is the phase identification strategy, but it has its advantages. For instance, a predictive model can help us get into a trade in a more timely basis. Forward looking analysis techniques include seasonal cycles, sentiment studies, and overbought/ oversold or diverging momentum studies to help spot possible sector rotation.
If you subscribe to the ValueTrend update newsletter, you will have received our newest update in your inbox today. If you don’t subscribe, click here to do so. I outlined a number of sectors and rotations we are moving into of late. One of those sectors is the Consumer Staples sector. We are dipping into the sector right now, with a small position initiated. But, as noted in the newsletter, we anticipate adding positions in the staples sector into the spring.
We have four reasons behind our desire to own a full position (10% or so) in consumer staples by the spring. They are:
- Value: many stocks in the sector are cheap. Not just on a relative basis to the market, but in some cases, on an historic basis.
- Seasonality: Consumer staples have a tendency to outperform the market between May and November.
- Technical Analysis: I have noted recently that there are enough reasons behind the markets rally of late to keep it intact. But many sectors are overbought. Staples are not overbought, and have corrected enough to merit initiating some exposure into a conservative portfolio. More on this below.
- TINA, momentum, and Fed stimulation: I have noted the potential for the power of these 3 incentives to wear thin over time, particularly those of market momentum and the diminishing effects of Fed stimulation. Should the party be getting late, this could cause a stock market rotation out of risk, and into safety. Staples are considered “safer” stocks on a relative basis to the market. Consumer staples might be a sector of stocks to buy now.
On the chart below, you will note that the staples section outperformed the S&P 500 leading into and out of the two strong market corrections in early then late 2018. The staples ETF also outperformed during the COVID crash and the weeks leading out of it. My green arrows on the chart point out the comparative relative strength line (XLP vs. SPX) in the middle pane.
You’ll also note that momentum has corrected from an overbought level in the recent pullback. True, they may roll over a bit more, pulling the ETF down further. But the new highs on the ETF along with a series of higher peaks and troughs on the chart (while remaining over its 40 week/ 200 day SMA) suggest there may only be minimal room for the correction to complete itself. It appears that an opportunity is approaching within this sector.
Consumer staples, along with a few other sectors noted on the ValueTrend update newsletter today, are not “hedges”. They will still decline in a market correction. But, seeing that its a little difficult to predict the exact timing of a pending correction, they are a decent compromise to holding cash in a still-rising market.
At ValueTrend, we are cognizant of the fact that certain segments of the market are extremely overvalued. We are convinced there is reason for an eventual rotation out of these overbought sectors and stocks – and we are convinced that that rotation will drive overall market indices into a correction. However, we are also quite aware of the positive momentum and breadth factors (as outlined in last weeks Bear-o-meter blog) that continue to push the market up…for now! As such, our strategy is to continue rotating into less vulnerable sectors one step at a time. When markets begin to show signs of rolling over, or upon a bearish Bear-o-meter reading, we will raise cash in addition to our sector rotation strategy. Keep reading this blog, and I’ll keep you in the loop!