The Futures / Inter Market Report Trading the World’s Markets August 31, 2007 Matthew Caruso, CMT
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This e-mail address is being protected from spam bots, you need JavaScript enabled to view it Sector Allocation The U.S. stock market has rebounded off its August low and as I stated on my July 27th letter, I think there is still strength in this market. The last hurdle for stocks will be the traditionally weak September & October months but once that time passes we will likely see much higher prices & new highs for stocks and the stock market. An important point to discuss however is which stocks are likely to perform the best in the coming months and possibly years. One of the best tools to use when trying figure out which sectors will likely outperform is comparative relative strength (RS). This week we will look at the relative strength for the Technology, Energy, Health, Materials, Industrial, and Financial sectors versus the S&P 500 by dividing their closing prices by the S&P 500 closing prices. The weekly charts of the RS for these sectors can be seen in Figures 1 to 3. With the financial sector receiving the blame for the recent market sell-off we will begin or analysis with the financial and health care sector which can be seen in figure 1. Although financial have been a great place to be from 2000 to 2004 they have since only performed similarly to the market. However, since 2004 the financial sector RS has formed a large double top which has now been triggered in. This points to under performance by financial stocks for at least the next year or more. In the typical sector rotation model financial stocks lead in the early stages of a bull market and under perform in the later stages of the bull market. The double top in the financial sector RS may be providing clues that this market is now maturing. The health care sector has been a major under performing sector since this bull market has begun and continues to do so. As seen on the left hand side of figure 1 the health care sector’s RS is still in a strong downtrend and would need to break the down trendline if it is to become a market leadings sector. 
Figure 1 Chart by Metastock The next two sectors under analysis are the industrial and material sectors and both can be seen in figure 2. Both sectors have generally been leading the S&P 500 during the bull market. The RS in the industrial sector has been trending upwards but contains many periods of drastic underperformance. The material sector’s RS has also been in an uptrend and continues to be in one. Although both sectors have been good place to be in since 2003, they have not been the best place to be since the August fall. Therefore, both sectors will likely out perform over the next year, but other sectors such as technology and energy provide better opportunities for short and long term investment of funds. 
Figure 2 chart by Metastock The last two sectors left to analyze are also the two best sectors to be in going forward. The chart of RS for the technology and energy sector can be seen in figure 3. The energy sector has been a consistent performer during this bull market and has led the market higher with technology after the August correction. Going forward, energy will continue to outperform as long as this bull market persists or the uptrend line of the RS is broken. Of all the sectors, the technology sector shows the greatest potential for market performance in the coming months and possibly years. After underperforming from 2004 to 2006 the technology has completed a bullish head and shoulders bottom formation that indicates out performance by the sector in the future. Technology stocks have been exceptionally strong recently and will most likely lead the market for the rest of the year. 
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