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Brief Update on U.S. Materials, Retail, Large Cap/Tech ETF Trends

(Econotech FHPN)--Like last week's article (May 24, "When Greenspan Talks, Do People Still Listen?" link) , this short update simply consists of three e-mails I sent out this morning.

Materials Sector Overextended on Unprecedented Global Boom and M&A

The global economy, led by China, India and other emerging markets, is in arguably its strongest five-year boom in history, in terms of sheer scale, scope and speed. The U.S. equity sectors that have benefited most are energy, materials and industrial. Attached is an update of the 4-year weekly chart of XLB, the materials sector etf, that I last e-mailed on May 4, left click once on it to enlarge for better viewing.

In my May 4 e-mail I wrote: "the XLB is now at the top of the regression channel (three parallel blue lines, which curve slightly on a log scale) for each timeframe shown [with just one exception of five separate charts of XLB from long-term to very short-term timeframes] ... in the past, XLB's strong uptrend has tended to pause and consoldiate when it reaches the top of these regression channels. There is some potential upside left ... of about another 1½ points, about 3.8%, which I would not rule out, given the current worldwide stock momentum."

That was when XLB was 39.23, it's now at 40.93. I.e. it is even more overextended or overbought at this point, e.g. one indication being the "stochastic momentum index" in the bottom panel. Obviously no one knows when the strong uptrend in the materials sector from its July 2006 lows (red trendline) will start to consolidate, but the odds of that happening usually continue to increase the higher this etf goes above its long-term regression channel (the parallel blue lines).

Nascent Defensive Market Shift Into U.S. Large Caps and Tech?

A possible nascent, defensive market shift into U.S. large cap stocks, including tech, continues. During most of the 2002-07 bull market, international, especially emerging market, and U.S. small cap stocks both dominated U.S. large cap and U.S. tech (the darlings of the previous cycle).

However, since the beginning of 2007, the 200-day moving average (ma) of SPY (S&P 500) relative to IWM (Russell 2000) has had its first sustained, albeit small, rise, meaning the long downtrend of U.S. large to small caps may, emphasis on may, be finally starting to change in favor of large caps. A similar picture is only just beginning now with respect to QQQQ (Nasdaq 100) relative to IWM, with this 200-day ma just now turning up in May.

The 200-day ma of SPY relative to EEM (emerging markets) flattened out in late 2006-early 2007. This followed a very large decline of about -40% in the SPY to EEM relative strength the prior two years. Since late March, the 200-day ma of SPY to EEM has slightly declined again.

The value of SPY relative to EEM made a potential double bottom in April, the first bottom at the same relative level being in May 2006, just before a brief strong rally in SPY relative strength as EEM sharply corrected down in May-June 2006.

A similar thing may happen if China's small correction this week were to deepen and/or spread to other emerging markets, sending money back into the perceived short-term safety of the heavily indebted U.S. economy and weak dollar.

Also as I noted in my last week's comment link, the alpha, risk-adjusted excess return, of EEM is now around zero, it just turned slightly positive again this week (alpha takes into account factors that relative strength does not, and also is more amenable to most fundamental analysts).

After the typical strong move in U.S. tech stocks in the first year of the 2002-07 bull market, I am usually somewhat skeptical of the long-term staying power of any U.S. tech rally in this cycle, viewing them as either seasonal (fourth quarter) and/or a potential sign of impending short-term consolidation of the far more powerful moves in the true market leading sectors in this cycle, such as international (both emerging market and non-U.S. developed), energy, materials and industrial, etc.

Shop 'Til They Drop U.S. Retail Stocks

The health of the U.S. economy usually means American consumers shopping 'til they drop (using East Asian and Mideast oil credit), no matter what else might seem to be going wrong (e.g. this week a correction in China's frothy equity markets that global markets have shrugged off so far).

Attached is a 4-year weekly chart, courtesy of Prophet.net, of RTH, the retail stock etf, that reflects this ongoing American shopping binge, left click on it once to enlarge for better viewing. RTH broke out of a long sideways consolidation (two parallel red lines) in the beginning of 2007, and is now threatening to break out above its recent resistance (short purple horizontal line).

Btw, this does not mean that U.S. retail stocks have been a preferred place to park investment capital, since they have had negative alpha, risk-adjust excess return (relative to the S&P 500 and U.S. interest rates), for most of the time since Sep 2005 (bottom panel), let alone greatly underperforming stocks and sectors exposed to the huge emerging market uptrend.

But it does indicate that, for now at least, investors in U.S. retail stocks still seem to think the American economy will be fine into the second half of 2007, as indicated by RTH's still intact strong uptrend since July 2006 (rising brown trendline, and rising red 200-day moving average).


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