Key Points
- Sector year-to-date performance is ugly. Only three sectors have performed better than the S&P 500.
- Taken at face value, the relative performances of the sector ETFs could mean trouble ahead.
- However, a deeper analysis shows this may not be the case.
Bloomberg Interview
There was an interesting interview on Bloomberg this past Friday. Tom Lee, often characterized as a Perma-Bull, stated the last quarter is likely to be good for stocks. He believes that hedge funds and other asset managers will need to make up for poor performance this year, and they will need to chase returns. This will push stocks up, and be a positive for the markets as a whole. However, there’s a caveat.
When the markets and sectors are in their present condition, they tend to perform poorly the next year. He said the last six of seven times this happened, the markets fell double digits the following year.
Year-to-Date Performance
Lee was looking at the year-to-date (YTD) performances of the individual sectors. The S&P 500 has returned 8.69% over the last three quarters. The combination of tax cuts and high consumer sentiment has helped bring record earnings to U.S. companies, and has propelled the index to all-new highs as recent as September 21.
Given this strong performance by the main index, we would like to see that most of the individual sectors follow suit. If they do, it means investors believe most of the economy is growing, and companies are expected to continue growing.
However, if we see the majority of sectors are underperforming it could signal cautious investors, or that only a select few segments of the economy are expected to grow.
As we can see in the chart above, only three sectors have performed stronger than the S&P 500. In fact, half of the sectors have negative returns for the year. Does this prove the stock market is weakening?
What Does the Technical Analysis Say?
After analyzing the individual sectors, the market does not look like it is an as much trouble as the YTD numbers might suggest. You can download the analysis here.
We use ratio charts to understand the relative performance of the sectors against the S&P 500. When the line moves up, it tells us the sector is performing better than the index. If the line moves down, the index is out-performing the sector.
The top three sectors: technology, consumer discretionary, and health care, have done well to support the index. However, only technology and discretionary stocks have consistently pulled the market up for the year. Health care has only performed well since it bottomed in May. The ETF has grown by 20% since.
Utilities and real estate have kept pace with the S&P 500 since the correction in January/February. Their YTD under-performance is mostly due to the correction, which began in December 2017 for them. This means that there are a total of 5 sectors supporting the index. However, it should be noted that utilities and real estate look like they are going to face some selling pressure over the short-term.
In addition, while the YTD returns look bad, the sectors themselves do not. Most of the cyclical sectors are still in uptrends, with the outlier being financials. The defensive sectors on the other hand look okay, which is a good sign for stocks. Of course, the outlier in the defensive sectors is health care, which looks great.
Conclusion
The stock market is behaving much differently this year, than compared to 2017. Of course, 2017 was historical and there may never be years like it again.
The correction in the beginning of 2018 had set the tone for the sectors. Some sectors fell hard, and are still trying to recover. A couple sectors fell, but quickly came back.
What we have seen this year is how diversification and sector rotation can benefit the S&P 500. When the industrials, materials, and financials fell, it was the support of the defensive sectors, such as staples and utilities, that kept the index from falling just as hard.
Then, when the index bottomed, it was the performance of utilities, staples, and real estate that helped bring the index back to its all-time highs. Suddenly, industrials and health care came back, and with the continued performance from technology and discretionary stocks, it helped the S&P 500 rise to new highs once again.
Sector rotation is a part of the S&P 500, and is one of the key reasons why it is important to properly diversify a portfolio. Relative YTD performances tell one story, but they don’t paint the whole picture.
For now, investors will want to watch for any signs of a top in the sector charts. If we start to see the sectors turn down, then it will be a problem for the S&P 500.
Visit https://www.brtechnicals.com/sector-rotation-provides-sp-500s-resilience/ to see all the charts!
Submitted October 01, 2018 at 05:38PM by BR-Technicals https://ift.tt/2NWqzrB
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