4 Reasons The Market Might Struggle In 2015

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Includes: DIA, EXI, FXG, FXU, IWM, IYE, IYH, QQQ, SPY, XRT
by: Chad Gassaway

Summary

Market is being led by defensive sectors.

Energy sector tops lead to market tops.

Possibly approaching a period of deflation.

The S&P continues to hit new all time highs day in and day out. When initially looking at this it seems very bullish. However, when you look under the hood the sector leadership is not what we would like to see.

1) Defensive Sectors Leading the Market

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Image courtesy of Chad Gassaway, CMT.

In 2014 the market has been led higher by the defensive sectors of the S&P 500. In fact, three of the top four leading sectors are defensive in nature (utilities, healthcare, and consumer staples).

In bull markets we like to see the market led by industrials, materials, and technology. With the exception of technology, these sectors are underperforming the broader market.

2) Consumer Staples Outperforming Consumer Discretionary

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Image courtesy of Chad Gassaway, CMT and Stockcharts.com.

In 2014 consumer staples are outperforming consumer discretionary by 10.38%. In order to fully understand why this matters we need to know what each sector is comprised of. Consumer staples include household items such as toothpaste, food, and beverages. These items are needed in both good and bad times. Consumer discretionary includes retail items such as apparel, automobiles, leisure products, and luxury goods. Consumer discretionary items are not essential and are typically purchased when times are good. In strong bull markets we want to see consumer discretionary outperforming consumer staples. The outperformance by consumer staples shows that investors are defensive in nature.

3) Energy Sectors Moves From Leader to Laggard

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Image courtesy of Chad Gassaway, CMT.

The energy sector was showing incredible strength until late June 2014 at which point it topped out.

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Image courtesy of Chad Gassaway, CMT.

The energy sector was a market leader from the beginning of the year through the end of June. Only the utilities provided better returns.

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Image courtesy of Stockcharts.com.

As shown on the chart above, energy stocks tend to perform the best late in a cycle. This is followed by an outperformance in the staples, healthcare and utilities sectors as we are seeing now. In most instances though the broad market tends to top with energy and we have yet to see this yet.

4) Possible Deflationary Cycle

Deflationary environments are typically marked with stocks and commodities falling while the dollar and bonds rise. As of now all but one criteria has been met. The CRB index is down year to date while the USD and UST both are trading higher. Should we see weakness in the stock market, this could be a sign that a deflationary cycle is beginning.

Image courtesy of Chad Gassaway, CMT.

This would be quite worrisome. The following quote by Martin Armstrong best sums up deflation.

"Empires do not die by hyperinflation - that is reserved for the fringe. When an empire dies it historically has always been deflation. Real wealth is driven from the above ground economy into the underground economy where it is hoarded and tucked away. This is why we find hoards of Roman coins." - Martin Armstrong.

While we are missing a key component (falling stocks), this is something to keep an eye out for.

In conclusion, all the intermarket analysis factors above could take months or longer to play out. Intermarket analysis should only be used to look at the market on a longer term basis. Most signs point to the market rallying over the following couple months but the aforementioned items could pose as a problem for the market in 2015.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.