Beta Shifting - Up

Today in the Research Edge morning meeting for our clients we said that if the S&P rallied to 711, the next level of resistance would be 754. (We update our model every 90 minutes and the level has changed to an immediate term breakout/breakdown line of 705). Given the massive move we are seeing today, this could happen very quickly.

To gain Alpha in the move to 754, you need to beta shift away from the “safety play.” At the time of writing, the top three performing sectors today are the XLF (Financials), XLE (Energy) and the XLI (Industrials). The corresponding beta on those three sectors are 1.6, 1.2 and 1.04, respectively. The only other sector outperforming the S&P 500 today is the XLY (Consumer Discretionary), with a beta of 1.2. With a beta of 0.52, the XLP (Consumer Staples) is showing a massive negative divergence.

While MCD is not officially in the XLP, it is representative of the issues associated with global consumer product companies that comprise the XLP. Yesterday, MCD reported remarkably strong same-store sales, yet overall sales declined given the currency impact. While most investors like to look through the issues of currency, the strength in the US$ is a big negative for all of these global companies, creating negative year-over-year comparisons. Analysts don’t back out the impact of currency when modeling operating EPS. That being said, from a bottoms up perspective the collective street is modeling 12% operating EPS growth for the XLP; not going to happen given the economic and currency headwinds.

Where to look… The XLE (Energy) double bottom tested on Friday and saw further follow through yesterday and again today. The XLE continues to make sense with oil in positive “Trend” position. The US$ is declining today, therefore higher beta assets like commodities and stocks will “re-flate.” The XLB (Materials) is a major beneficiary of this trade.

We have cited numerous examples over the past week where fundamentally, things are looking less bad in 1Q09 from 4Q08. We continue to like early cycle Technology, Consumer Discretionary and Gaming stocks.


Howard W. Penney
Managing Director