Sector Rotation: Utilities and Healthcare Waking Up

Posted by jbrumley on April 15, 2021 9:32 PM

It's fun to pick stocks, but the fact is, that's only a little more than half the battle. It's been said that 40% of a stock's movement merely reflects the movement of the sector it's a part of. Point being, if you pick the right sector then you're halfway speak.

With that as the backdrop, it's noteworthy that a couple of the market's decidedly lagging sectors since last March's low are suddenly coming on strong. That's healthcare and utilities.

The graphic below tells the tale. Strangely, staples, utilities, and healthcare - areas that should perform well when the economy is pressured - haven't proven particularly popular in over a year. Investors have opted for higher-growth areas like technology and discretionary names, or industrials and materials and energy, which tend to perform in periods of economic strength. While things could be worse, much of any economic strength witnessed in the midst of the pandemic has been artificially driven.

Whatever the case/reason, things are changing now. Over the course of the past week, healthcare and utilities are the second and third-best performers, losing out to materials.... and materials are a bit too overextended to trust now. For the past month, the 4.7% gain utilities stocks have gained are the market's second-best to technology stocks, which are also a bit overbought. Healthcare has never led of late, but has consistently performed better than average for the past few weeks. Take a look.

Most of the time, chasing a trend is a fruitful trading approach. You want to plug into the biggest and fastest trends, and leaders are leaders for a reason (even if that sector is leading the market lower). Leadership doesn't last forever though. While it's tricky to spot when rallies are end and new ones are beginning, this sort of visual comparison makes it easier. It's also telling that the disparity between the market's leading and lagging sectors has been so wide of late.

It's always good to get a second opinion, of course, so...

The Healthcare Select Sector SPDR ETF (XLV) is our proxy for the healthcare sector. Drilling into its daily chart shows us some good and bad news about this breakout effort. The bad news is, it's already technically overextended by healthcare stock standards. The good news is, there's still some room left for the fund to keep moving higher before bumping into an established technical ceiling that connects all the key highs since April of last year (orange).

For the record, biotech stocks and healthcare technology names are the less-overextended names here, and most primed to make the most of this budding rotation.

The Utilities Select SPDR ETF (XLU) looks a lot like the chart of Healthcare Select Sector SPDR ETF does here. That is, already overextended by utility stock standards even if the group's underperformed for the past 13 months. Nevertheless, there's room for upside... particularly if the overall market starts to deteriorate and traders start searching for safety.

Electric utilities make up most of the fund's and sector's holdings, and more or less look the same, chart-wise. That's where most of the opportunity is. Don't overlook water and natural gas names though. All of these stocks are picking up steam.

This is all theoretical, preemptive stuff, of course. This budding rotation may peter out before it gets going in earnest. The current leaders may renew their bullishness. Nobody really knows, and smart traders watch everything all the time.

Still, given how easy it is to look past budding trends while looking for splashier trades, this sudden strength from healthcare and utilities is something to think about if only because nobody else sees it coming.