Sector Action: The Trader’s Wind Sock

Wednesday, 19 Dec 2012 07:40 AM

By Patrick Watson

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Smart traders keep an eye on sector momentum. Why? The same reason pilots look at a wind sock. They want to know which way the wind is blowing – before revving up the engine. Investors like you also want the wind in your favor.

Broad-market benchmarks like the Dow Jones Industrial Average and the Standard & Poor’s 500 are useful, of course. They tell us whether investors are generally bullish or bearish. Because they are so broad, however, they don’t always tell the whole story.

Looking back three months, for instance, the S&P 500 declined overall. At the same time, healthcare and financial services stocks posted solid gains, while technology and energy lagged way behind.

Will the next three months look like the last three months? No one knows. Maybe the same trends will continue, or maybe they won’t. Any trend-following strategy is akin to driving with only a rearview mirror to guide you. You can do it until the road makes a sharp curve.

I like to ask whether the current trends make intuitive sense, based on everything else I know. In this case, why are healthcare and financials doing so well? And why are technology and energy falling behind?

One obvious factor is the election. With President Barack Obama still in the White House and Democrats still controlling the Senate, Obamacare is set to move forward. I’m not saying this is a good thing, mind you, but we must face the reality. Businesswise, Obamacare’s implementation is a positive factor for insurance and pharmaceutical stocks.

Financials are a bit more puzzling, since Wall Street pushed hard to get Mitt Romney elected. They lost that bet, but they at least have the Federal Reserve still on their side. Fed Chairman Ben Bernanke’s easy-money policy is good for the banks.

Technology and energy are both capital-intensive industries. Inventing and exploring new oil and gas deposits require a lot of up-front cash. Other factors are at play, too, but tax increases on the wealthy probably won’t help tech or energy stocks.

What would help is some clarity about the government’s tax and spending plans. Instead we are being dragged through ugly fiscal cliff negotiations that, as of this writing, seem likely to stretch into January. Whatever emerges could extend the current sector trends — or reverse them.

The wind sock is ready to swing. Now we need some wind.

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