With U.S. stocks trading at an all-time high, which sectors have been driving the rally and which might now be the strongest? To answer that question, technical traders can assess relative strength versus the broad market.
In technical analysis, relative strength measures how powerful a move is compared with a benchmark. This can be done by dividing a section of the market by an appropriate benchmark. For example, a sector’s relative strength can be determined by dividing its daily closing prices by daily closing prices of the S&P 500® Index. Relative strength analysis states that the stronger a sector is against an index—like the S&P 500—the more likely it is to continue to rise, and vice versa.
The advantages of relative strength analysis include:
- Ease of use
- The ability to see intermarket relationships
- Compatibility with other technical indicators
It’s important to recognize that relative strength does not take into account the different risk factors of what is being compared, and it can be skewed by large price spikes. However, relative strength is widely used and can help you find trends.
A business cycle framework
One helpful strategy when assessing relative strength is to consider the business cycle. According to Dirk Hofschire, CFA®, senior vice president of asset allocation research at Fidelity, “The U.S. economy as a whole appears to be doing reasonably well, in a solid, mid-cycle expansion.” This stage of the business cycle tends to be most beneficial for the economically sensitive industrial and technology sectors.
So, how strong are these and other sectors compared with the rest of the market?
The primary trend for the consumer discretionary sector looks solid (see the top chart). Clearly, the sector is getting support from the 50-day moving average. Additionally, the trend relative to the broad market, as measured by the S&P 500, appears to be firmly in place (see the bottom chart).
While most other sectors are showing similar trends from an absolute and relative basis, industrials are displaying some divergence. The primary trend for the sector by itself has been moving sideways for several months, after a sustained uptrend (see the top chart, below). Over the past several weeks, the sector has been reverting to the 50-day moving average, yet is still well above the 200-day moving average.
Against the broad market, however, industrials have clearly weakened, forming a rounding top thus far in 2013 (see the bottom chart). This suggests weakening relative strength against the rest of the market. There looks to be some support below the current range. However, there is a risk that the industrial price chart might begin to confirm what is happening against the broad market, and that is a potential weakening.
Last year’s market leader, financials, continues to remain in a primary uptrend (see the top chart, below). Both by themselves and on a relative basis compared with the S&P 500 (see the bottom chart), financials look bullish.
As the top chart below shows, energy has recently broken through the downward-pointing 50-day moving average, a bearish move. However, it has tested the 200-day moving average, which did hold as support. Energy has moved relatively flat compared with the S&P 500 (see the bottom chart), despite being in a primary uptrend since the summer of last year.
Like most other cyclical sectors of the market, materials have looked positive (see the top chart, below) over the past year or so. This is a reversal of the prior period when the primary trend was down. However, the materials sector has had to use the 200-day moving average as support recently, and the chart does show some signs of a move sideways, rather than up.
Compared with the rest of the market, the materials sector has been a laggard over the past year, due in large part to the sluggish global growth environment. As a result, on a relative basis materials have been weak against the S&P 500 (see the bottom chart). Signs of a firmer move against the S&P would be a favorable sign for this sector.
It has been a volatile 2013 for tech stocks. As the top chart below shows, the technology sector has been moving in a channel, alternating between strength and weakness. On a relative basis, the picture is much clearer: The sector is in a primary downtrend versus the broad market. It should be noted that it has recently turned higher versus the S&P 500 (see the bottom chart.)
Unlike the closely related information technology sector, telecom is currently displaying strength on both an absolute and relative basis. The primary uptrend has been going on a little bit longer, and appears slightly stronger (see the top chart, below). Both are clearly upward sloping at this point.
It’s worth noting that some analysts do not place much weight on this sector’s relative performance, which has been choppy (see the bottom chart) over the past couple of years. This may be due to the fact that telecom is largely a low-beta, high-yield play, as opposed to being a strategy based partly on relative strength.
Like consumer discretionary, trends in the consumer staples sector appear strong on a relative basis. Consumer staples are in a very defined slope up (see the top chart, below). While the relative strength versus the broad market is not as bullish as consumer discretionary, it’s still on an uptrend (see the bottom chart).
The primary trend remains bullish for the health care sector, both on an absolute and relative basis. The sector is on a clear trend higher and is holding well above both the 50-day and 200-day moving average (see the top chart, below). However, for a sector that has performed very well over the past year, there has been some recent weakening relative to the broad market (see the bottom chart).
On a stand-alone basis, utilities are in the midst of a very strong uptrend. The sector is trading well above both its 50-day and 200-day moving average after having broken through the mid- to late-2012 highs (see the top chart, below). Against the broad market, utilities appear to have broken the downtrend that had been in place until the early part of 2013 (see the bottom chart).
Like telecom, however, some analysts do not place much significance on relative strength analysis for the utility sector due to its identity as a low-beta, high-yield play.
It is possible to draw a number of conclusions from relative strength analysis. Given that the S&P 500 and Dow Jones Industrial Average have both recently hit a new all-time high, Jeffrey Todd, technical analyst with Fidelity, thinks that traders might want to watch the relative performance of the cyclical sectors more closely than others to determine if the rally might continue.
“I would say that stronger relative performance for the consumer discretionary sector would be an encouraging indicator of general stock market health because of its strong link to consumer spending—which is by far the largest contributor to the U.S. and world economies,” Todd notes.
On the flip side, during the spring in each of the past three years, emerging relative strength in defensive sectors—like consumer staples, health care, telecom, and utilities—has presaged substantial losses for the S&P 500, according to Todd. “This recent trend is one factor that makes investors anxious to see more relative strength in cyclical sectors as confirmation that the market is in good shape.”