Market review 24.05.12

A focus on short- and long-term relative strength

Hello everyone,

As a trader, I’m asking two questions each week: Do we want to be risk-on, and if so, what are the leaders?

In early April, I wrote a blog post titled “Short-term bearish, medium-term bullish.” In it, I discussed the possibility of a shallow 5-7% pullback to retest breakouts on various ETFs before resuming higher. We got just that, with ETFs such as XLB and XLF correcting 6%, followed by a recovery:

I maintain that the medium-term is bullish before a growing list of worry signs (discussed in recent posts) could matter later in the year.

OK. We want to remain risk-on. So, what areas have the highest upside potential? Relative strength provides us with clues.

Let’s first assess strength over a longer timeframe to uncover the mega themes. The past five years have been like a washing machine for markets, with multiple drawdowns and sharp rallies. Over this bumpy timeframe, what ETFs have produced the strongest and cleanest uptrends? Using the Sharpe Ratio as our metric for trend quality, we can uncover the true signal from the noise: