The Broken RORO

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The risk-on versus risk-off trade, aka RORO, has been the modus operandi (MO) of many investors over the past several years. The Fed is going to goose the market? I’m going all-in the beta trade. Europe is imploding and the euro will cease to exist tomorrow? Sell, Sell, Sell! Now, current data suggests that investors may be thinking in a new and different way. It’s possible that the RORO trade has been broken.

Typically we could see the risk rotation very easily. In stocks you’d see a move out of expansionary sectors like consumer discretionary, industrials, financials, technology, energy, and materials. The defensive sectors are staples, utilities, and health care. Usually, the onset of defensive sector outperformance tells of a rotation out of beta-chasing sectors and into defensive ones. Fund managers and investors move into the lower beta stocks in anticipation of a market correction. The defensive, lower beta stock sectors include utilities, health care, and consumer staples.

On a weekly basis, I follow a strict discipline and review all of my macro and micro technical indicators on the health of the market. One of the important steps in this process is the review of sector performance. You want to watch for turns in sector strength to identify market rotation. The best way to monitor sector performance is through relative strength analysis.

Relative strength analysis is a big word for simply dividing a sector by the market to get a ratio we can plot. If the number begins to rise, that means that the numerator (sector) is outperforming. If the number begins to fall, that means that the denominator (market) is outperforming the sector (usually because of other sectors). The easiest way to plot this relationship is through To divide a security by another on StockCharts, you simply put both symbols in their symbol field with a semicolon in between, as shown here:

relative strength

Understanding this simple tool and using standard technical analysis techniques (such as trendlines) to understand the trend and trend reversals can put you head and shoulders above many other individual investors. This technique can be used to gauge many relationships in the market. Another twist is to divide a security by its sector to see if it’s leading the sector, but I digress.

I primarily wanted to explain that sector rotation is happening and how I came to that conclusion. I’ve just explained my methods and now it’s time to show you the data. Let’s look at healthcare, consumer staples, and utilities to determine if performance is shifting into these defensive, risk-off sectors.

Healthcare Relative Strength

I use the S&P select Health Care SPDR fund and I then divide it by the S&P 500 to understand whether health care is underperforming or outperforming the general market. Looking at the chart below, it’s not only clear that health care stocks are indeed outperforming, but that the outperformance trend is also accelerating.

heathcare up curve

It’s understandable to see that health care is performing very well. Individual charts within the sector have some of the best looking charts out of the multiple ones I screen within the S&P 500, with plenty of upside room. One thing you should note, as in the past, health care tends to outperform the market when investors start shifting to defensive, lower beta plays. This happened last year from April to July, September through October, and from February to date. Every time the relative strength ratio of health care divided by the S&P 500 bottomed (top portion of the chart), the market underwent a significant correction (bottom portion of chart).

healthcare calls top b

The only thing that’s different this time is that health care has not underperformed yet (a declining XLV:$SPX line). Health care was in line with the S&P’s performance, minus a small dip in December, since late October. It is only in February that this changed and health care resumed its outperformance trend, and recently, that trend has accelerated. Does it portend a market correction as portfolios shift to lower beta? Let’s look at the other risk-off sectors to come to understand.

Consumer Staples

In the same way that we’ve seen the performance of health care stocks bottom just before the stock market corrected in 2011 and 2012, we see the same relationship in another defensive stock sector: the consumer staples. Every time the relative strength ratio of staples divided by the S&P 500 bottomed (top portion of the chart), the market underwent a significant correction (bottom portion of chart).

consumer staples

Like health care, is this time different? Staples aren’t just rising with the market, they’re leading! This is an interesting development to the prognosis that the investors are either fully chasing beta in risky stocks or they’re out of it in defensive stocks. Or, the outperformance in defensive sectors is a precursor of a market correction.

sector performance


The last sector to review is the utility sector. I especially want to focus here because I see an inflection in utility performance, and because the swings have had long-term implications for the path of the S&P. Notice in the past that bottoms and tops in utility performance have signaled turns in the stock market? This was due to the prevalence of the risk-on versus risk-off trade. All-in or all-out of beta, there was no middle ground.


Notice that starting in January, utility performance bottomed. Usually that spelled doom for the stock market, but the stock market continues to jog along its upward track.


Based on my analysis of sector performance and rotation, the data seems to point towards more questions than answers as of late. Is there a shift in market sentiment out of the all-in and all-out beta trade, otherwise known as risk-on versus risk-off? If nervous investors are coming back to the market, as the fund flow data indicates, are they comfortable buying Zynga and First Solar or are they more comfortable buying a Johnson and Johnson and Coca-Cola? In a low-interest rate environment, do you want to buy bonds, or would you be more comfortable buying a blue-chip stock growing its earnings at a single-digit pace, a 3-4% dividend yield, and they’re buying back stock? More and more investors are picking the later choice. It’s quite possible that the market is rising in defensive stocks, and outperformance in defensive stocks, might not be a bad thing for once.

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About Ryan Puplava CMT