Sector Rotation Shows a Slight Flight to Safety, From Risk

Posted by jbrumley on June 22, 2018 4:56 PM

Another trading week is in the books, and though the market booked a modest loss in it, a slew of traders have chalked it up to (a) the calendar, (b) profit-taking, (c) pre-breakout jitters and (d) [insert your explanation here.]

And, maybe they're right. Maybe the broad market is just doing its usual back-and-forth thing.

There's a nuance, however, that says something sinister may be lurking beneath the surface.

You can tell a lot about investors' mood by identifying the kinds of stocks they're buying, and the kinds of stocks they're selling. When traders are looking for market bullishness, they tend to love technology names, with a side of financial stocks. When they're planning on seeing weakness, they tend to gravitate towards names that (presumably) better hold up in a tough environment. That's usually utility names, though relatively-more-predictable consumer staples stocks get a little more love than usual in uncertain environments.

But the past is no guarantee of future results? That's certainly true enough. Investors, as a group, can often misread what's looming on the horizon.

They usually don't though, which makes what's happened over the course of the past week so interesting. Last week, reversing a bigger-picture trend that's been in place for a while, utilities led the way with a 1.8% gain. Tech stocks were dragging the bottom with a 1.4% loss, though industrial goods actually did worse, losing 2.9%.

It's a move from offense to defense... an idea underscored by the week's other winners and losers.

For a little (ok, a lot) more perspective though, check out the performance comparison chart below, examining how each sector has performed on a day-to-day basis going back to June 22nd, 2017. Tech had been leading for a long, long time, and utility stocks has been lagging for a long, long time.

Also notice that industrials and materials - two pretty good proxies for growth - took a steep dive, while a relatively defensive healthcare sector (aqua/turquoise) didn't take too much of a hit last week. Similarly, though they didn't do great last week, consumer goods are perking up after a long performance drought. In fact, if you take a step back and look at the picture from a transitive perspective, you can see there's actually been a slow shift in leadership taking shape for a while now. That's called sector rotation.

In that vein, there's more to this analysis than just taking investors' temperature. This information can tell you a lot about what's plausible, and what's happening, and what's about to happen.

Though it's possible for a sector to lead (or lag) for months and months on end, it's unusual. For a bunch of different reasons, groups fall in and out of favors. Last year's winners are often next year's losers, and last year's losers are often next year's winners. You can't be afraid to take-profits at highs and buy into sectors dragging the bottom. Those disparities reverse, given enough time.

Of course, sector rotation is just one part of the puzzle. It still pays to note straightforward technical and fundamental information. On the flipside, in that most people can't or won't study sector rotation trends, understanding what's going on this regard offers you a big advantage.