Three Month Sector Rotation Insights

Often, the Sector Rotation model can give us insights into a deeper structure of the market, and can highlight possible clues for the pathway ahead.  Let’s take a look at the absolute and relative performance of the major AMEX Sectors and see what they might be hinting to us.

AMEX Sector SPDRs performance *Relative* to the S&P 500:

In the first graph, we ‘zero-out’ the S&P 500 (^GSPC) and then compare the outperformance or underperformance of the nine major sector ETFs to see where opportunities might exist.  Keep in mind that we can have a sector outperform the S&P 500 return over a period of time, yet still decline - as is the case currently.

The three best - in fact only - relative outperformers come from “Defensive” sectors in Consumer Staples, Health Care, and the Utilities.  Traditionally, money managers ‘rotate’ positions here during down markets or contractionary economic cycles.  Remember that many money managers are required to be ‘long’ the market at all times - they attempt to outperform the market by ‘losing less’ than the market during difficult (down) periods.

Over the last three months, the Financial sector suffered the greatest underperformance relative to the S&P 500, despite all efforts to stabalize them

Sector Rotation can help in determining “Hedged” positions or portfolios, in terms of selecting strong stocks in the strongest sectors and then countering them by ’shorting’ weak stocks in the weakest sectors.

Let’s turn now to Absolute Performance measures (percentages) over the same three-month period.

AMEX Sector SPDRs *Absolute* performance:

Virtually everything money managers have touched in the stock market has declined - there are so very few pockets of resilience.  If you aren’t required to be long in this environment, do not do so.  There’s no need to be a hero.

Over the three-month period from late September to late December, the Financial sector lost 43%, followed next by the Materials sector which shed 39%.  All other sectors are underwater for this selected period, though again we see the three classically “Defensive” areas lost the least money (roughly 16% each).

What does this tell us?

We’re not out of the woods by any means yet and the market is still likely to remain in a downtrend.  Money tends to flow from left to right on the Sector Rotation model, the way the graph is drawn.  This means we could expect the next source of strength to come from the Financials and Consumer Discretionary (Retail), and when we see those sectors ‘perk up,’ we will have a clue that investors are seeing better times ahead.

We’re not there yet.  The Sector Rotation model continues to hint at defensive postures or perhaps avoidance of the market completely (in terms of investment horizons)… although bonds do not offer much of a respite (in terms of very low yields).

Stay safe and continue to compare sectors for signs of emerging strength or continued weakness.

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