Sector Rotation in Progress Currently

Is that the Santa Rally I hear making noise? Yesterday I discussed the markets are set up for a correction. In my comments I stated that we could see a move higher prior to that taking place if investors continue to buy on the dips. On Wednesday we saw exactly that intaday buying. As the S&P 500 index approached the 1400 level of support, buyers stepped in and bought stocks. As I pointed out in last nights notes, the buyers were helped by positive economic data centered on the ISM Services numbers moving  higher in November than October and well ahead of expectations. The weak component of the report was the employment weakness. That is not surprising considering the jobs report continues to be weak. Bottom line, the stars are aligning for the end of the year push higher for stocks. This move higher does not negate my outlook for a correction on the horizon, and we do have to be cautious about how we trade this move going forward.

Positive takeaways from Wednesday’s trading day…

  • Financials found interested buyers. The move to $15.85 or resistance was a positive today for the SPDR Financial ETF. The attempted move above this level and towards $16 was even better. The leadership came from Bank of America up more than 5% base on the outlook for improving mortgage business, and Citigroup which gained more than 6% on announced layoffs and cost cutting at the bank. The large cap banks need to exert stronger leadership if the sector is going to push back to the October highs or beyond. I continue to like the sector and look for more leadership if the broad indexes are going to continue higher.
  • Healthcare has made a positive turn back to the upside as well. The providers (IHF), medical devices (IHI),¬†pharmaceuticals¬†(XPH) and biotech (XBI) are all in position to push the broader sector higher. Having the leadership of the sector is key for the broad index as the size of the sector makes a difference in how high the overall broad indexes will rise.
  • Industrials made a solid move off support and they are pushing back towards the previous high. There were some solid moves higher from several stocks, but more importantly is the pattern breakouts in many of the stocks jumping from consolidation patterns to an uptrend. The move in the sector is bullish for the broader indexes as well. This is a sector worth digging into to track the leaders as the stocks will¬†outperform¬†the overall sector short term.

Negative takeaways from Wednesday’s trading day…

  • Basic materials continued the aggressive move lower. Freeport-McMoRan (FCX) dropped 16% on Wednesday to lead the downside for the sector. They are on the move to expand their base revenue exposure with the¬†acquisition¬†of Plains Exploration & Production (PXP) and McMoRan Exploration. Investors didn’t like the news and sold the stock. Throw in some downside pressure in the precious metals and you get the current move lower. Not willing to step in front of a train, but it is worth watching to see how this plays out short term.
  • Consumer Service sector has struggle since the retail sales reports for Thanksgiving were announced last week. The negative data is feeding on itself and there are stocks like Macy’s (M) dropping nearly 10% in a week that have put a strain on the sector. Don’t count the sector out on this news, but instead dig in and look for the leadership. ANF, IGT, GT, GME, AMZN, & FDO are just some of the positive momentum stocks in the sector currently.

One last factor to consider from the last week of trading is the opportunity in the dividend stocks following the fear based selling on the ‘fiscal cliff’ potentially raising taxes on dividends. First of all we don’t know what the outcome of the current fiscal budget negotiations will bring. Everything is speculation based on rumors. Until we have a definitive answer of how taxes will impact the landscape of dividend stocks the selling is likely overdone. I believe there will be solid opportunities for the dividend stocks and REITs that sold lower on the doomsday propaganda. Look at the chart of DVY, iShares DJ Select Dividend Index ETF and you see the V-bottom move higher for the index ETF. This opportunity is worth the time to dig and filter for the winners. I expect these stocks to remain in favor even if the we go off the cliff with taxes. Remember that bond yields are 1.6% on the 10 year Treasury.

Today we are looking for a push towards the top end of the current resistance at  1420-1430. How it plays out from there is why we have to be patient and disciplined. It is still a dangerous market relative to short term risk, but the risk thus far is worth taking and managing the risk of the trades or investments. One day at a time is the key.