Thursday, March 12, 2015

An Updated Look at Sector Correlations and More

Identifying short term tops and bottoms is an incredibly difficult task and something that is unlikely to be done with any consistent certainty.  We choose to follow a specific set of indicators in an attempt to gain a sense of when the market might be putting in a top or bottom over various timeframes.  

For instance, in our Tuesday post, we highlighted the McClellan Oscillator, bollinger bands, stochastics and simple trend lines to show that while the market had moved lower rather swiftly, it had yet to start flashing the oversold extremes that we prefer to see.  

Another indicator we wanted to revisit is the rolling 20-day correlations of several key S&P 500 market sectors.  Simply told, the sectors within the index become highly correlated when the market gets really oversold because people just want to get out.  We've posted on the topic before and think it's really useful when trying to zero in on extreme readings.  As of yesterday, the indicator had yet to reach levels that have been typical of recent short term bottoms.  If you look at the data going back to 2013 in which the "buy the dip" strategy has ruled, we want to see correlations quite a bit higher than where they currently stand before declaring a market bottom.  As with any other indicator, there's absolutely zero chance this measure is infallible on its own but we like to see scenarios where it backs up/compliments the other gauges we follow.  While we're seeing a strong bounce in the market today, we'll be keeping an eye on sector correlations to see how they respond.

Another area we are focused on just like every other talking head is the dollar.  The chart below shows the rapid advance in the last 6 moths.  The USD is currently trading near its upper channel line.  This could act as resistance and bring about some weakness in the near term.  As part of our scenario analysis we've been scanning to see what effect a potentially weakening dollar would have on equity prices.  In fact, if you've yet to start investigating the matter, the Fat Pitch Blog just published his findings and they'd be a great place to start.  His stats show a very mixed bag.  We're going to keep digging.  

Ryan Worch is the Managing Director of Worch Capital LLC. Worch Capital LLC is the general partner of a long/short equity strategy that operates with a directional bias and while emphasizing capital preservation at all times.

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