Sector rotation: a short term bullish sign for the stock market


The stock market is experiencing sector rotation. The Dow was up 0.6% yesterday while both the Russell 2000 and NASDAQ fell.

Whereas small caps and tech stocks led the rally while large caps lagged during the first half of 2018, large caps are now leading while small caps and tech are lagging.
Here’s the Dow (large caps) : Russell 2000 (small caps) ratio. Notice how this ratio has been going up since July 2018 (i.e. large caps have been outperforming).

As you can see, the Dow:Russell ratio is on the verge of closing above its 200 day moving average for the first time in approximately 5 months. In other words, the Dow has underperformed the Russell for a long time, and this underperformance is coming to an end.
The Dow:Russell ratio is on the verge of closing above its 200 day moving average for the first time in >113 trading days. Here’s what happens next to the S&P 500 (historically).

Conclusion

As you can see, the U.S. stock market (S&P 500) does well in the short term (1 month) and also does well in the long term (9 months later). There’s only 1 really bearish case, and that’s the April 17, 2000 case.
This study demonstrates that sector rotation isn’t bearish for the stock market: it’s a normal part of bull market rallies.
Click here for more market studies

2 comments add yours

  1. It would be great if you could explain how the size factor is related to sector rotation.

Leave a Comment