Markets Continue to Rise into 2007. Growth is More Important Than Safety

By: Donald_W_Dony

The long-term relative strength analysis between the S&P 600 Small Cap Index and the Consumer Staples Sector ETF is a very valuable indicator that investors should monitor closely. This is because it provides an important timing tool for determining the top of the four year cycle and the stock market.

The driving momentum of both the S&P 600 Small Cap Index and the Consumer Staples Sector are different and each develops strengths or weaknesses at separate times during the normal unfolding of the four year cycle. It is this change of performance that is key to understanding where the crest of the stock market lies.

At the start of a new bull market, investors are still concerned about company earnings and the present economy. A defensive approach to investing in equities is often taken which has a positive affect on the consumer staples stocks and a general negative influence for the riskier small cap companies.

At this time, the Consumer Staples Sector would usually be out performing the S&P 600 Small Cap Index and the line would be in decline. As the economy increasingly improves and investors confidence increases, slowly more funds are shifted into the higher profit potential equities and less into the safe and defensive staples group. This movement of capital progressively rebalances the performance in favour of the small cap stocks. As the economy expands and heats up, investors continually look for increasing profit potential in equities and additional capital swings out of consumer staples and into the aggressive small cap sectors.

After several years of expansion and near the peak of a bull market, several fundamental and psychological events often occur. Interest rates have usually risen, oil prices are at a record high level and a portion of investors grow increasingly concerned about the duration of the bull market and begin shifting money out of the higher risk investments and back into more defensive stocks.

Chart 1 shows the relative strength performance of these two opposite stock groups over the past three years. During 2004 to May 2006, the S&P 600 Small Cap Index rose at a faster rate than the more safety-oriented Consumer Staples Sector ETF and created an up trend. However in late May 2006, the long-term trend line favouring small caps stocks was broken. This indicates that the Consumer Staples Sector was now out performing S&P 600 Small Cap Index. This new pattern continued until October 2006 when the down trend reversed and began climbing again.

MY CONCLUSION: Longer-term analysis indicates that this change of trend line usually develops at or near market tops. This simple comparison of two opposite financial groups can often provide investors with another important tool to recognize when stock markets are likely to peak. Presently the trend line remains up with no indication of reversing.

Your comments are always welcomed.

By Donald W. Dony, FCSI, MFTA
www.technicalspeculator.com

COPYRIGHT © 2007 Donald W. Dony
Donald W. Dony, FCSI, MFTA has been in the investment profession for over 20 years, first as a stock broker in the mid 1980's and then as the principal of D. W. Dony and Associates Inc., a financial consulting firm to present.  He is the editor and publisher of the Technical Speculator, a monthly international investment newsletter, which specializes in major world equity markets, currencies, bonds and interest rates as well as the precious metals markets.   

Donald is also an instructor for the Canadian Securities Institute (CSI). He is often called upon to design technical analysis training programs and to provide teaching to industry professionals on technical analysis at many of Canada's leading brokerage firms.  He is a respected specialist in the area of intermarket and cycle analysis and a frequent speaker at investment conferences.

Mr. Dony is a member of the Canadian Society of Technical Analysts (CSTA) and the International Federation of Technical Analysts (IFTA).

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