I decided that, at this juncture, it would be appropriate to break down the stock market by technically analyzing sector Exchange Traded Funds. ETF's are an excellent way to diversify within any particular industry group while also positioning oneself correctly in the business cycle (provided you can see thru the central bank distortions to understand where we are in the business cycle). By comparing the relative strength or weakness of these industry groups to the broader S&P 500 this methodology can assist us in correctly assessing where we are in the business cycle as well as taking advantage of institutional money flows in and out of these industry groups.
Let's start with a broad overview. Here's a weekly chart of the S&P500:
Regardless of momentum divergences, there is nothing on this chart that suggests we are presently in the midst of anything more than a "garden variety" correction.
Here's the Financial Select Sector ETF (XLF) which is comprised of the money center banks (JP Morgan Chase, Wells Fargo, etc.), American Express and Berkshire Hathaway:
1. Although it is undeniable that stocks have suffered short term technical damage, for the most part, major support has not been broached in almost all of the sectors.
2. The fact that the defensive sectors have not responded more positively to the recent market weakness tells me that we are simply in a normal correction in an ongoing bull market.
Now, here's my caveats:
1. Home building (ITB) needs to shrug off it's interest rate induced weakness and resume it's uptrend. This will provide the necessary validation for the position articulated by many that the US economy can withstand sustained higher interest rates.
2. I've already beat this horse before but we need to see the inflation rate start to head higher. While it would be premature to start addressing the possibility of a "liquidity trap" the present year over year inflation rate of 1.2% is too low and is speaking to a weak economy. In such an environment, I would propose that a "hiccup" in the economy could find us in a deflationary situation. And deflation + QE = liquidity trap! Indeed, the price action of commodities and gold are continually warning us of this possibility.
Anyone who follows the market knows we're going to be in for a rough ride in September. The big event is the Fed September 17-18 meeting where the consensus seems to indicate that Bernanke and company will start an incremental process of taking away the punch bowl. Market reaction to such a policy decision will tell us much about the true condition of our economy and the financial markets. And, of course, we have a new chapter in the "fiscal follies" brewing in Washington as it appears Dems and Republicans are already positioning themselves for budgetary brinkmanship. The German election on September 22nd will see Angela Merkel as the winner but the configuration of the Bundestag will be watched closely as her effectiveness could be impacted if her coalition majority is upset. I'll be addressing these issues more specifically as we get closer to these events.
That's it for now. Thanks for your support and have a great week!