June 19, 2018

In 1588, a man was in a cathedral. He looked up and saw a chandelier swinging back and forth. At first, he thought that it demonstrated continuous perpetual motion. This launched an extensive investigation. Although this man, named Galileo, tried to integrate pendulum motion into timekeeping machinery, it was Christian Huygens, a physicist and mathematician, who used Galileo’s findings to produce the first clock in 1657. This pendulum motion was later used to develop the Clock Tower in Westminster, London, England, commonly known as “Big Ben,” an efficient timekeeper for the last 159 years.

Pendulums are cool because they work by converting energy back and forth, like a roller-coaster. When the pendulum is at its highest and looks like it has stopped, it has the highest potential energy. When it swings to its lowest point, that potential energy is now kinetic energy, which then swings up and converts back to potential energy. This happens repeatedly. If there were no friction or drag, which steals potential energy, the pendulum would swing forever. But even as a pendulum swings in shorter and shorter arcs, the time it takes to cover a smaller distance is the same. This is what Galileo figured out and this is why he thought that a pendulum would serve as a perfect timekeeper.

Pendulums are based on motion and momentum. I see the market as a huge pendulum. There is price momentum and momentum of emotion, trends, thoughts, feelings, money, everything. These individual swings can be observed, of course, but the big show is where the broad market measures, such as the S&P 500, reach their breaking points, low or high. Then we see the pendulum swing the other way.

In late January, the market pendulum reached its height and swung wildly backwards. Fear and anxiety took the helm and drove market prices lower. Here we are in June and the pendulum has swung significantly in the other direction. Cheer, optimism, and satisfied stock owners rule the roost now. The question is, how close are we to the top? That answer comes in a few parts.

The first part is the market itself. The broad indexes are at or near all-time highs. The Russell 2000, laden with small cap and growth stocks, is the clear leader now. This is followed closely by the tech-heavy NASDAQ Composite. The S&P 500 is not too far behind, near its highs, with the DJIA last in tow.

If we look under the hood at the sectors, we can see what is powering those indexes higher. Looking at last week’s performance, and other recent time periods, we can see leaders and laggards. What do we see?

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Consumer Discretionary Rises to the Top of the List

The past week saw a surge in Utilities, perhaps boosted in part by dovish tones from the Fed. But notice which sector was second: Consumer Discretionary. That’s interesting, because there has been much talk about Energy and Tech lately. But the Consumer Discretionary sector has been a less obvious powerhouse of the market in the past few months. Naturally, I have been talking about it here for a while and now the CD sector has quietly edged out Information Technology in all time periods in the tables above.

For my money, this is a great thing. This means consumers have more money to spend and are feeling more prosperous. They are flooding their money into the economy and buying discretionary goods. This is a sign of a strong economy. With tech running neck-and-neck, we see two major growth forces driving markets higher. This is bullish and strong.

Energy quickly fell back after going heavily overbought a few weeks ago. Despite that stumble, the Energy sector is still the strongest in the past three months. But what is clear as day is this: In the past time periods, Consumer Staples, Telecom, and Utilities are the weakest sectors. These defensive sectors are dragging on the market while the growth heavy sectors are pushing it higher.

Naturally, the end game is to find the biggest winning stocks. If we look further down within the sectors, we can see what has curried favor. Currently, in Consumer Discretionary we are seeing restaurants, discount retailers, apparel, and footwear companies getting bought by institutions. If we look within these groups for companies growing sales and earnings and profit margins, while managing debt and remaining priced at reasonable multiples, it is here you will find the big winners right now.

Don’t forget, while the breathless financial media encourages the viewer to think moment-to-moment and day-to-day, the earnings cycle runs roughly three months. These stocks attracting capital now are being bet on for more than just a day. I would expect to see some continued strength in these areas based on solid growing fundamentals coupled with technical strength and institutional support.

As we climb higher, approaching dizzying heights, the pragmatic investor asks, “How close to the top are we?” In other words, “How far are we from the next fall?” Well, according to the metrics I look at, we are not quite yet overbought, but we are rapidly approaching those levels. In short, the pendulum is swinging closer to its apex. It’s worth stressing that I believe any correction that comes near-term will be technical in nature. The fundamentals are solid for the backdrop of consumer market strength mid- to longer-term.

Near-term, we want to be careful of a market that gets out ahead of its skis. We are not there yet, but we are closer this week than we were last week. In any event, should there be a market slip in the upcoming weeks, I would view this as a buying opportunity. Pendulums swing back and forth, exhibiting the laws of nature and physics. We keep time and rhythm based on them. Look for these pendulums in the market.

In any event, remember: “You’ve got to keep moving, keep moving.” – Lady Miss Kier.

About The Author

Jason Bodner

Jason Bodner writes Sector Spotlight in the weekly Marketmail publication and has authored several white papers for the company. He is also Co-Founder of Macro Analytics for Professionals which produces proprietary equity accumulation/distribution research for its clients. Previously, Mr. Bodner served as Director of European Equity Derivatives for Cantor Fitzgerald Europe in London, then moved to the role of Head of Equity Derivatives North America for the same company in New York. He also served as S.V.P. Equity Derivatives for Jefferies, LLC. He received a B.S. in business administration in 1996, with honors, from Skidmore College as a member of the Periclean Honors Society. *All content of “Sector Spotlight” represents the opinion of Jason Bodner*


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