The stock market is baffled about its next broad move, although trends that are just developing may clarify where the best prospects lie. Nevertheless, decisive trends among the 10 market sectors have been scarce in both the Canadian and U.S. markets.

Within some of the 10 sectors in both markets, a few industries are clearly doing better than the overall market. These bright lights are scattered: diversified mining (industrial metals), automobiles and components, software and services, paper and forest products, capital goods, oil and gas equipment and services, oil and gas drilling, and oil and gas storage and transportation (the long name for pipelines).

This reinforces the picture of markets that are not yet organized in a trend with clear leadership. Thus, it makes current portfolio construction difficult.

Going by relative performance of the markets’ 10 sectors, utilities and consumer staples are becoming the strongest areas. Relative strength of consumer discretionary and industrials is also rising.

However, these are relatively small portions of the Canadian market. Latest 12-month earnings of the utilities sector subindex is $9.8 billion; consumer discretionary, $5.2 billion; consumer staples, $2.3 billion; and industrials, $4.5 billion.

Absent from the list of the strongest performers are the dominant sectors of the Canadian market: financials, energy and materials. The energy sector lags because its dominating component — oil and gas exploration and production (E&P) — is flat.

Latest 12-month earnings of the E&P subindex are $8.6 billion, with the energy sector’s total earnings at $14.3 billion. The financial services sector’s 12-month earnings are $19.6 billion, while the materials sector shows a 12-month loss of $3.2 billion.

Hopes for an early resurgence of the financial services sector are weak because banks ($13.9 billion in earnings) are the weakest of all industry subindices in the S&P/TSX index system. Until one or more of these sectors muscle their way into a market-leading position, the S&P/TSX composite index (with latest 12-month earnings of $47.5 billion) will struggle.

There are positive long-term indications from the industries that are performing better than the market. One is paper and forest products, a leading indicator in the business and market cycle. Consumer and auto stocks are also performing better than expected, considering the economic climate. And the capital goods subsector — usually a late-cycle mover — is an early and pleasant surprise.

There is also hope for an energy surge later because, traditionally, oil and gas stocks rally late in a market cycle.

Relative strength is an invaluable pointer to portfolio construction, as your clients will want to own stocks in industries that are doing better than the market — and get out of those trailing the market.

There are several ways of measuring relative performance. A basic method is to divide the price of a stock or subindex into the price of a benchmark, such as the S&P/TSX composite index. Over a few weeks or months, you will (hopefully) discern a decisive trend. The ratios are purely arbitrary, hence why “relative” is the key description.

A useful alternative or supplement to this basic relative strength ratio exists. It permits ranking of stock against stock, or index against index. Robert A. Levy developed it in his groundbreaking study published in 1968, The Relative Strength Concept of Stock Price Forecasting.

Levy’s method is to take a ratio of the latest price to an average of recent prices — which, in his research, is a 26-week average. But a six-month average works well, too. Levy found that stocks with high ratios of price vs average price tended to remain superior performers for the subsequent 26-week period. IE