Sector Rotation Tells the Tale

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The S&P 500 closed at 1432.12 today, a new 52-week high as well as a 4-year high since the market recovery began in 2009; however, not every stock in the S&P 500 is hitting 52-week highs. As always, there is an ebb and flow to the market, and the sector rotation model tells the market tale. Very simply put, I wanted to skip the central bank theatrics, the economic extraction, and bull/bear bias by simply telling the market performance story. I want to tell you, “what’s working” and by telling you what’s working, deduce where the market is anticipating the economy is going.

Sector Rotation states that different sectors perform for better or worse, based on the highs and low of the economic cycle. When utilities, healthcare, and staples outperform the market, portfolio managers are shifting their allocations into a defensive posture as the economy shows signs of weakening economic activity. When technology stocks and consumer retail stocks outperform, portfolio managers are shifting weightings in anticipation of a market bottom and a recovery in economic activity. Finally, when basic materials, energy, and industrials outperform it’s because investors are anticipating the economy is in full recovery and resource supply is getting tight relative to demand. Martin Pring and John Murphy have put together a diagram that depicts this relationship on, shown below.

Description: Sector Rotation Model

So that’s the model. What’s the real world showing? From the beginning of the year until now (ytd), the top performing sectors that have outperformed the S&P 500 are technology, financials, and consumer discretionary. That’s almost exactly how the year got started. GDP was growing at a healthy clip, jobs data was strengthening, and the ECB was providing banks with a lot of cheap credit at 1%. There was a hiccup between March and June when when concerns shifted again towards Europe and our economic data began to wane. At that time utilities, healthcare, and staples began to outperform as portfolio managers made tactical shifts towards those defensive sectors. The manufacturing data on Europe and China began to roll over in March.

sector rotation model 22 sep 2012

As you can also see from the chart above, the last month has shown a recovery in technology, financials, and consumer discretionary, while the defensive sectors (utilities, staples, and healthcare) have lost some performance. That trend looks pretty solid. Here were the returns for August and the last few days:

august performance till now

I went through all 500 charts of the S&P 500 stocks and found the best looking areas continue to be the top three performing areas last month. Many of the financial stocks are benefiting from housing data and economic activity. The semiconductor stocks were on fire today as a result of all of the new products being announced. Better housing data is helping to lift the consumer sector as housing, retail, and other consumer-sensitive industries anticipate better economic activity ahead.

There’s a reason not every stock is hitting 52-week highs just like the S&P 500 is doing. It’s called sector rotation. Some sectors are falling out of favor while others are being weighted more favorably than others, like technology, financials, and consumer discretionary. That’s why it’s a good idea to always check the pulse of the market. That market is the barometer of investors’ anticipation of economic activity. The market is telling a story, and the sector rotation model is telling us we’re not in a recession, but early recovery.

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About Ryan Puplava CMT