The least movement is of importance to all nature. The entire ocean is affected by a pebble. -- Blaise Pascal
Even though we're only in the third trading day of the year for 2012, there has already been a tremendous amount of change happening internally within the markets. On Tuesday, Utilities (XLU) fell apart while the S&P 500 rallied. Further weakness continued in defensive sectors such as Consumer Staples (XLP), and Healthcare (XLV), even on quiet days for overall market movement. Treasury Inflation Protected Securities (TIP) are performing nicely, while long bond yields (TLT) have been slowly creeping up.
It is as if with the blink of an eye inflation expectations are returning. Perhaps the best way of thinking about this is how a ketchup bottle works. If central banks around the world have been shaking the ketchup bottle with no result, perhaps now is the time when the ketchup (inflation expectations) spills forth. Could it be that the Winter Resolution trend I have been talking about will be a bull market up move, despite Europe?
Market internals seem to be suddenly betting on rising inflation expectations, and should this continue, I think it's game on for the bulls. What would really cement this is if the financials (XLF) sector sustainably outperforms. And yes – it appears that this may indeed be in the early stages of happening -- finally. Take a look below at the price ratio of the Financials Select Sector SPDR ETF relative to the S&P 500 (IVV). As a reminder, a rising price ratio means the numerator/XLF is outperforming (up more/down less) the denominator/IVV.
We all know that financials have significantly underperformed markets since September of 2009, when the above price ratio peaked. The ratio got hammered all of 2011. Looking at the far right of the chart, it does appear to be the case that bets are being placed on banks in what could be the start of an early period of outperformance in the sector. I am not making a fundamental case for banks here. Everyone knows that banks face collateral problems. Everyone knows about Europe. The question is if markets have over or under-reacted to that. If bad news is overly priced in, then financials could lead the markets higher. The Winter Resolution may bring the bull back for real this time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
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