What a difference a year makes. The S&P 500 (SPY) was already up over 12% by this time last year and is close to flat year-to-date. In 2014, we’ve already experienced a 5% correction, a down January, and a massive reversal in momentum stocks (MTUM). By now it should be very clear that the benign environment that persisted throughout 2013 is over.

Importantly, we’re also seeing changes in sector leadership, with defensive sectors outperforming and the commodity-driven Energy (XLE) and Materials (XLB) sector showing improving relative strength.

Collectively, this is classic late cycle behavior, which should not be surprising as we are almost five years into the economic recovery than began in June 2009.

The Materials sector in particular has been showing relative strength leadership over the past few months (see chart below).

This should provide another tailwind for the commodity-sensitive Emerging Markets (EEM), which already have valuation and sentiment in their favor as I’ve written about in prior articles.

Emerging Markets have underperformed developed market for over three years now, and we may be in the early stages of a significant reversal.

Over the past five weeks, Emerging Markets have outperformed U.S. small caps by over 11%, the widest spread since 2010 (see chart below).

Importantly, this spread was achieved with Emerging Markets moving higher and U.S. small caps moving lower, which is the exact opposite of what we saw in 2013 (see chart below).

Overall, investors should be mindful of the underlying message the markets are sending us here. While the broad U.S. averages are close to flat on the year, we’re seeing a significant rotation going on underneath the market that is potentially indicating that we are entering the latter stages of the economic cycle.

While that doesn’t necessarily mean U.S. markets will finish down this year, it is likely a harbinger of higher volatility in the months to come. We last saw this in 2007, another year that exhibited late cycle behavior and higher volatility with the broad averages still finishing higher on the year. With this in mind, I continue to believe that investors should be more focused on risk management this year.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.