“There cannot be a crisis next week. My schedule is already full.” – Henry A. Kissinger

One of the most underappreciated market dynamics over the last several years has been the fact that the bull market in US stocks has largely been led by all the wrong stuff. Bull markets tend to be led by those parts of the economy most sensitive to growth and inflation, i.e. cyclical and high beta sectors.

Instead, the sectors that have led equities higher have been the exact opposite, as low volatility and yield became the theme of the moment for new money wanting exposure to risk assets.This is abnormal, and clearly a side effect of central bank interest rate manipulation. However, just because we live in an anomalous cycle does not mean that historical relationships won’t re-assert.

So here we are in 2016, and bonds are arguably anticipating the end of the world with yields negative in many corners of the global landscape. On the surface, one would think it makes sense to continue buying into dividend plays because on a relative basis, stocks yield more than many bonds. This dynamic, however, can only last so long. At some point, dividend plays aren’t the bull investor’s choice, but rather the bear’s way of mitigating downside volatility if one must have exposure to stocks at all time. This is fully consistent with the research behind our Beta Rotation Index (click here to view) which plays defense by positioning into Utilities (XLU), Consumer Staples (XLP), and Healthcare (XLV).

I believe we are currently at what may be a secular inflection point as the ratio of the PowerShares S&P 500 High Beta Portfolio (SPHB) relative to the PowerShares S&P 500 Low Volatility Portfolio (SPLV) tried to make a trend change.A rising ratio means high beta cyclicals are outperforming (up more/down less) the denominator/SPLV.Low volatility stocks, from a performance perspective, have significantly outperformed the part of the marketplace you would think would have done very well in a bull market.

We can see in 2016 a higher low in the ratio relationship has taken place as money tries to position into high beta stocks. However, if this does not hold and low volatility goes through another pulse of outperformance (sending the ratio lower), I suspect it will likely occur not in an advancing phase for the S&P 500 (SPY), but rather a correction or downtrend. This would reassert the historical relationship of how low volatility stocks historically has performed depending on if the market is in a bull or bear phase. 

Bottom line? If another push higher is coming for equities broadly, cyclicals may finally have their day in the sun and lead in the next wave. If, however, the ratio trends lower yet again, it may be warning of a potentially serious decline and risk-off move to come.