Monday, April 13, 2009

The Exit Strategy.

Spring has sprung and so has the stock market. The current sentiment looks like we may have a classic "Sell in May and go away" - but with a twist. More about the twist later. The below chart and information on the Business Cycle/Economic Cycle - provided from - is a good place to start from when determining which sectors to be in and when.

Legend: Market Cycle(Red) Economic Cycle (Green)

This theoretical model is based on Sam Stovall's S&P's Guide to Sector Rotation and states that different sectors are stronger at different points in the economic cycle. The graph above shows these relationships and the order in which the various sectors should get a boost from the economy. The Market Cycle preceeds the Economic Cycle because investors try to anticipate economic effects.

The current intermediate trendline is still in tact, but at a pivotal moment as the chart shows. If this trendline holds here, we can see a fast move higher. The resistance zone matches up with a May sell signal.

If we look back at the business cycle/economic cycle we can see the models shows that finanicals lead. In this current market, financials are leading in the last month and are helping make a case that a bottom is being put in place. As the market made new lows in February, so did the KBW Bank Index (^BKX), and while many other indexes did not reach new lows - indexes such as the PHLX SEMICONDUCTOR SECTOR INDEX(Philadelphia: ^SOXX) and the AMEX GOLD BUGS INDEX(AMEX: ^HUI)
- a relative strength collage started to emerge. Everyone knew without the financials though, everything was off the table - the market could not recover. But now that the financials have bounced - in a big way - and currently lead on a 1 month relative basis off of the bottom, the promise of a new market/economic cycle is showing improvements, and sector rotation is currently being construed: financials/transports, technology/basic material, and then energy/commodities.

1 Month Relative Performance

3 Month Relative Performance

6 Month Relative Performance

Notice the AMEX GOLD BUGS INDEX(AMEX: ^HUI)is lagging on the 1 month basis, which confirms that they should be the last to run. They have clearly been the strongest sector in the 6-9month timeframe.

According to the cycle rotation, we should continue to see sector rotation out of financials - this does not mean that banks can't go up, it just means they will lag now - with transports still showing some room to outperform short term - the outperformace of the transports will give us DOW THEORY, and will confirm that we have a classic sector rotation off the bottom. Look for money to start moving into technology stocks/basic materials also in the short term, and outperformance till May sometime. This coincides with the "sell in May" theory. This is the sell signal and where we can start looking for money to rotate back into energy/commodities for summer. At this time, a good strategy would be 50% cash 25% hard assets and 25% stocks. Over the summer, look for the markets to be flat, and hard assets to outperform.

The Twist:

The twist is if Gold breaks out and over the 1,000 mark - if that occurs, we could see commodities begin a spectacular rise to create some of the best returns in commodities since its secular awakening. But nonetheless in this new risk averse world, don't count your chickens until they hatch, or in modern terms - sell them before the expiration date.