Leading indicators signal a market top

A bearish story is being told by the relative performance of the market’s various sectors.

That’s because the sectors with the best year-to-date returns are among those that typically lead the market prior to major tops. In addition, the sectors exhibiting the worst performances this year are those that typically lag.

We know how the market’s sectors have performed prior to past tops because of data from Ned Davis Research, which analyzed all bull market tops since 1970. According to the firm, the sectors that on average have performed the best over the three months prior to those tops are Consumer Discretionary, Consumer Staples and Health Care.

As you can see from the chart above, these are the very sectors that are at the top of the ranking for year-to-date performance, according to FactSet.

In contrast, the three sectors that prior to past major tops were the worst performers, on average, are Utilities, Energy and Financials. And, sure enough, they are the three worst year-to-date performers.

To be sure, this is not the first occasion in which one or another of these sectors have been at the top or bottom of the three-month performance scoreboards. But it’s rare for all these sectors’ performance rankings to fall so closely in line with the historical template for performance prior to major tops.

Consider where these sectors stood in January 2013, when I last devoted a column to their recent performance. On that occasion, Financials were one of the best performing sectors over the trailing three months, while Consumer Staples was one of the worst. That was inconsistent with the historical template of past tops, and — needless to say — early 2013 was not a market top.

Why would consumer and health-oriented sectors lead the market prior to a top? The theory is that the demand for the products of companies in these sectors is relatively immune to the economic cycle. We always need food and health care, for example. These sectors will therefore be among those least hurt as the economy turns down.

Market Watch

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