Survival of the fittest is probably the animal kingdom’s most dominant theme. Survival of the fittest is also a concept well established on Wall Street; just ask Bear Stearns, Washington Mutual, or CIT Group.

Every major business cycle has winners and losers, leaders and laggards. The players change, the cycles change or reverse, but the concept remains the same.

New cycle – new leadership

Towards the late 1990s, technology (NYSEArca: XLK) ruled the roost and drove the market to never before seen highs. The Nasdaq (Nasdaq: ^IXIC) briefly poked above 5,000, a level it hasn’t even come close to since.

What goes up must come down. This certainly proved true with respect to the dot.com bubble. Tech stock maintained their leadership role, the direction, however, reversed from up to down. Aside from Apple and Amazon, tech-stocks have not been able to reclaim their lofty highs.

Cycle reversal – leadership pattern continues

As technology crumbled, Americans found comfort in real estate (NYSEArca: VNQ). Rising prices and home equity lines of credit made up for a dwindling 401(k) balance. Real estate led the way out of the 2000 – 2002 mini recession.

The real estate sector had a partner in crime – banks. Without the aid of banks and other financial institutions, property prices could never, and would never, have risen as much. The real estate and financial sector formed a symbiotic relationship and flourished for years.

Even though property prices started to fatigue in 2005, the real estate investment sector and financial sector kept plowing forward until early 2007. First real estate ETFs started heading south, banks and financial institutions followed shortly thereafter. The cycle and the players remained the same, but once again the direction changed.

From 2007 to 2009, financials and real estate were the worst performing sectors around, losing between 70 and 80%.

Another reversal – same leadership

Unexpected for Wall Street, the financial media and most others, the broad market bottomed on March 9th 2009. Financials and real estate did so a few days earlier and – true to form – ran ahead of the market, this time it was up.

Just before this major change of trend, the ETF Profit Strategy Newsletter sent out a Trend Change Alert on March 2nd, which prepared investors for the monster rally ahead and recommended to start buying long and leveraged long ETFs.

Some of the predictions given via the Trend Change Alert were:

“A multi-month rally, the biggest rally since the October 2007 all-time highs, should lift the indexes by some 30-40%. Tuesday's (2-26-09) 4% spike may be an indication of the initial intensity of the rally.”

“The Ultra Financial ProShares (NYSEArca: UYG) could morph into one of the best performing ETFs over the next few months.”

“Dividend ETFs with a higher allocation to financials are likely to rise higher than the broad market.”

As predicted, the financial sector maintained its leadership and led the pack. Within half a year, the Financial Select Sector SPDRs (NYSEArca: XLF) gained 156%, the SPDR KBW Bank ETF (NYSEArca: KBE) rallied as much as 168%, and sky-rocketed more than 330%.

The leaders are starting to lag

The rally from the March lows was broad and convincing, but the nature of the rally is changing. Unlike the broad market which continues to rally, banks and financials peaked on October 14th.

The picture for the smaller banks that don’t fall under the “too big to fail” witness protection program, looks even worse.

The SPDR KBW Regional Banking ETF (NYSEArca: KRE) hasn’t reached a new high since August 7th. The iShares Dow Jones US Regional Bank Fund (NYSEArca: IAT) staged one more high on September 16th, and has been stuck in a lack-luster range ever since. This is not surprising, since nearly one bank per day is added to the dreaded “failed bank list” published by the FDIC.

One of this week’s failed banks was San Francisco’s United Commercial Bank, which received $299 billion of bailout funds last year. The FDIC estimates that United’s failure will cost the FDIC fund some $1.4 billion.

Bearish non-confirmations

Just as a unanimous vote carries more weight than a fragmented vote, a concordant market is healthier than an out of sync market. In fact, it’s been said that a fragmented market is a sick market.

Besides the weakness seen in the leading sectors, there is another glaring non-confirmation. On Monday (11-9-2009) the Dow Jones (DJI: ^DJI) pushed to a new 13-month high, while the S&P (SNP: ^GSPC) was not able to break above the October 19th high. True, the S&P may soon join forces with the Dow Jones (it would be a very bearish sign if it doesn’t), but other concerning facts, such as below average volume, remain.

For over a year, commodities have more or less mirrored the performance of equities. Silver, gold and equities have been laughing and crying together. Gold (NYSEArca: GLD) was able to rally to new all-time highs, silver (NYSEArca: SLV) wasn’t. In fact, silver is still about 20% below its March 2008 all-time high. More than gold, silver is an industrial metal and therefore, more sensitive to economic cycles.

Shouldn’t silver rally if the economy has truly bottomed? Should fear about a system collapse, government debt, or dollar decline subside if the economy has truly bottomed? Fear is abundant, why else would gold rally?

Don’t sweat the small stuff – focus on big opportunities

Only time will tell whether this cycle’s market top will be at Dow (NYSEArca: DIA) 10,200 and S&P (NYSEArca: SPY) 1,100, or slightly above, but regardless of where the top will be, it should be a major and long-lasting one.

It’s easy to get swooped away by the positive noise, but savvy investors look beyond the obvious - if it’s too obvious, it’s obviously wrong. At times of rising prices it’s easy to forget that the best time to buy stocks is when nobody wants to own them. Conversely, the best time to sell stock is when they are in favor.

Economists, Wall Street and the media have heralded the end of the recession, but where were they in March 2009 or October 2007, when we could have used a solid piece of advice? Announcing the end or beginning of anything after a 50% move is not an act of bravery.

Believe the data, not the opinion

The past few weeks were rich with economic data released, much of which received a positive spin – such as last Friday’s unemployment report. Rather than focusing on the interpretation of the data, it might be helpful to let the data speak for itself.

P/E ratios: Depending on which website you check, the P/E ratios for the S&P 500 range from 15 to 20. Most of those are based on projected earnings. Standard and Poor’s just published a P/E ratio, based on actual earnings, was north of 80. This is lower than last month’s 138 but still grossly over-valued.

Dividend yields: Dividend payments are a direct reflection of a company’s health, or lack thereof. Dividend yields are closing in on their all-time highs reached in 1999, right before the burst of the dot.com bubble.

Mutual fund cash reserves: Fund managers were invested to the max in August/September 2007, right before the collapse. Today’s mutual fund cash ratio is almost as low as it was over two years ago.

Historical guidance, probably the best point of reference available, shows that a market bottom has always been associated with low, very low P/E ratios and high, very high dividend yields and mutual fund cash reserves. Extreme P/E ratios and dividend yields show that fair valuations have been reached, while extreme mutual fund cash ratios show that the sentiment is right for a change.

None of the above indictors has reached levels indicative of a market bottom. In fact, all of them point towards much lower lows. Just as a lion doesn’t give up hunting until it captures its prey, the stock market keeps on declining until fair valuations are reached.

Only the “fittest” investors – those who plan ahead – are able to withstand the price correction associated with a severe valuation reset.

The November issue of the ETF Profit Strategy Newsletter includes a detailed analysis of P/E ratios, dividend yields and mutual fund cash levels, along with target levels for the ultimate market bottom, extracted from the implications.