Market timing is difficult to master at the best of times, even for those individuals claiming to be experts on the topic. Today, I would like to show you how the Consumer Discretionary sector can provide a clue to where the stock market is headed.
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If you have studied sector rotation theory, you will understand that the Consumer Discretionary sector starts to perform in the depths of recession. This is somewhat obvious as consumers must lead the way out of recession.
It is therefore important to monitor what is happening with this sector, as it leads the economy. I would argue that the Consumer Discretionary sector is the only part of the market that you should be watching. So building at least some of your market timing indicators based on discretionary alone should be a priority.
I would like to show the reader one such market indicator, based on analyst ratings. Start by creating a custom universe specific for the Consumer Discretionary sector, starting from the PRussell 3000. PRussell3000 is Portfolio123's equivalent to the Russell3000.
The next step is to create a custom series that will be based on analyst ratings. The formula is: 2*AvGRec13WkAgo-AvgRec. This formula is partly contrarian but also includes the best 13 week change in rating. In other words, the custom series will give the best results when the sector is out of favor but also making moves up the analyst ratings. This should be a good early indicator. The custom series calls up the custom universe created in the previous step.
UnivCapAvg(...), a MarketCap-weighted average, is used to create the aggregate figure representative of the entire sector. The criteria for aggregate inclusion is "AvgRec13WkAgo!=NA & AvgRec!=NA".
The custom series was generated weekly and shown below. I have deliberately blocked out the areas of the time series that are not of interest. As you can see, this indicator started rising in late 2008, and peaked sometime in mid-2009. This is well before all stocks on average started to show signs of health. In fact, earnings didn't start growing Year-over-Year until 2010.
Lets compare the above custom series to series based on sectors that are considered trailing or defensive sectors: Staples, Health, and Utilities.
Notice the difference in the 2008-2010 time period? This indicator can be used as part of a market timing strategy or sector rotation strategy. And the good news is that there are probably a lot of other indicators that you can design based on leading sectors. You are limited only by your imagination!