I often hear the assumption by media pundits that in any kind of a move higher in equities, the energy sector would outperform and that commodities are the way to play a rising stock market.
While this may have been true for the past few years, I actually think that the next bull market gets led by financial exchange traded funds and not energy.
Consider that China’s economy is clearly slowing down, and that it has been the greatest driver of commodity demand for pretty much the last decade. More so than that though, from a contrarian standpoint, bearishness is immense in the financials sector, so why couldn’t it be on the verge of a multi-year period of strength?
Take a look below at the price ratio of the Financial Select Sector SPDR (NYSEArca: XLF) relative to the Energy Select Sector SPDR (NYSEArca: XLE). They are sector ETFs. As a reminder, a rising price ratio means the numerator/XLF is outperforming (up more/down less) the denominator/XLE. Focus not on the ratio but on the trend itself.
Notice how long and severe the weakness in financials has been relative to the energy sector, and how consistently energy outperformed financials since the second half of 2010 (independent of the Fed’s QE2 program and Operation Twist announced this year).
I’m a fan of simplicity, and quite frankly, the longer something underperforms for, the more likely it is to outperform. I suspect that market participants are now expecting a coming global shock and awe to the European crisis which can force inflation expectations back into the subconscious of the crowd.
This would be bullish for the highly leveraged financial system. More so than that though – if you were going to bet on financials, wouldn’t you want to do so after such a long period of bearishness by the crowd? If not now, when?
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