In lieu of market barometers

in Wells Fargo Advisors by

By Hall Sumner

Andrew Thrasher makes an interesting case for there being a new market barometer in town.  So long, Dr. Copper and hello, Semiconductors:

“There used to be a belief on Wall Street that copper had a Ph.D. in economics since it was often used as a barometer for the economy and often the market. Traders would look for divergences between the copper and the equity markets for signs of potential danger. If Dr. Copper began to weaken it was believed that the stock market would soon follow. While this may have been the case at one point we would argue it no longer is today or has been for a few years now.

Dr. Copper in our opinion has been replaced by technology, specifically semiconductors. The market seems to be much more focused on the happenings of Silicon Valley rather than Milwaukee or Detroit. While the industrial sector still remains a large piece of our economy it no longer is the driver of growth. At least that’s what price action has been telling us. It seems Copper has been expelled while the semiconductors step to the front of the class.”

Seems logical and the charts are compelling.  So, what should we do with this information?  Follow the lead of Semiconductors, right? Perhaps, this relationship lasts 3 years; perhaps, it lasts 30 years.  The problem is that we won’t know until after the fact that the market has moved from Semiconductors on to the next leading indicator.

Furthermore, what if the lag of a given market barometer is 9-12 months on average.  We suspect that this is another one of those market tendencies that sounds great in theory, have some truth to them, but are pretty tough to implement from a portfolio management perspective.  How does this approach to risk management differ from the previous approach of reliance upon Copper (or now Semiconductors)?

Rather than hoping that a relationship between a given commodity or sector to the broad market persists in the future, we believe relative strength can help dictate allocations.  Admittedly, rather than being early to take defensive action, you will be somewhat late (by definition, a trend following strategy like relative strength never gets out at the exact top).  However, if a relative strength strategy is designed to help mitigate some of the downside risk in major bear markets with the objective of attempting to avoid the problem of a market barometer completely failing from time to time, doesn’t that make more sense?

The relative strength strategy is NOT a guarantee. There may be times where all investments and strategies are unfavorable and depreciate in value.

This article was written by Dorsey, Wright and Associates, Inc., and provided to you by Wells Fargo Advisors and Hall Sumner, CFP®, Financial Advisor in Beaufort, SC, 211 Scott Street, (843) 524-1114. Wells Fargo Advisors did not assist in the preparation of this article, and its accuracy and completeness are not guaranteed. Investments in securities and insurance products are: NOT FDIC-INSURED/NOT BANK-GUARANTEED/MAY LOSE VALUE. Wells Fargo Advisors, LLC, Member SIPC, is a registered broker-dealer and a separate non-bank affiliate of Wells Fargo & Company.  CAR 0115-02940