Owen Williams, CFA, DBA, is founder and strategist at Williams Market Analytics, LLC, which offers regular market commentaries; access to actionable proprietary trading models; trade set-ups/idea generation; and external fund management.
Dr. Williams has over 16 years of experience in market research and technical analysis. After working several years as an economist at Ned Davis Research, he has served clients for the past 12 years as a money manager both in Switzerland and the U.S.
He holds a Master of International Business Studies (University of South Carolina), a Doctorate in Finance (Grenoble Ecole de Management), as well as the CFA charter.
Equities: Equities Need Sector Rotation To Keep Rally Alive Over The Summer
06/09/2017 | 11:12am CEST
In a market which defies traditional valuation metrics and where everyone who buys equities is a genius, the only “investment strategy” today is to bet that the central bankers’ asset bubble will continue to inflate. The “Powers That Be” (the computer algorithms and central banksters) won’t allow equity price dips to last more than several hours. However we believe that for broad equity indexes to continue higher (at least into the rough August/September timeframe), that more sectors must participate in the rally.
Recall that for most of 2017, equity markets have been driven higher by a single engine: technology. And more specifically, gains have been driven by the Big 5 (Apple, Amazon, Google, Facebook, and Microsoft), which as of this week represent 13% of the S&P 500 total market capitalization. Narrowing participation is indeed a risk for the equity bull market, as historically fewer stocks participate in the last stage of a bull market.
Seeing a broadening of participation would seem to be a sine qua non to keep equity indexes moving higher. In addition, seeing lagging equity sectors begin to outperform would assuage concerning signals from the bond market (U.S. 10-year T-Note hitting lowest yield of the year this week), from gold (flirting with $1300), and from lackluster macroeconomic indicators (were not seeing the expected 3% plus GDP growth in the U.S. nor are we seeing strong numbers around the globe). Not to mention the distinct possibility of Trumps pro-growth agenda getting stalled out in Congress.
In the first section of this Commentary, we review the sectors that have driven gains thus far in 2017. In the second section, we present the recent laggards that we believe must come alive to keep the S&P 500 moving higher. For those maintaining a bullish bias, this second group of sectors is where we recommend seeking outperformance in the coming months.
Within a bull market, sector leadership tends to rotate as investors take profits in stocks that have outperformed and move into relatively cheaper stocks that have lagged. A sort of relative mean reversion. We saw an excellent example of this behaviour in 2015 with rolling bear markets in various sectors (banks, industrials, telecoms, utilities) while the broad S&P 500 held steady.
The outperformers thus far in 2017 all fall within one sector: technology. While not an indication of falling prices for tech in the near-future, the probability of continued outperformance diminishes over time simply because once a trade becomes too crowded there are few buyer left to push prices higher. Astute investors begin looking to take profits and move into relatively attractive sectors (see our second group below).
By far the most crowded trade on the planet today is U.S. technology, shown below relative to the broad U.S. market (Russell 3000).
Equally impressive is the outperformance of internet stocks, led obviously by Facebook, Google, and Amazon.
In terms of outperformance, the semiconductors (+27% YTD) are the winners thus far in 2017.
And the technology craze is not just a U.S. phenomenon. In Europe, the Stoxx Technology Index is the big outperformer in 2017.
And in Japan, the MSCI Japan Information Technology Index is blowing away the Nikkei.
While almost every other major sector is in a relative downturn compared to the broad market indexes (heavily weighted in technology), we present below some clear laggards since January.
The U.S. banking sector, which initially fueled the Trump rally in November, has cooled off in 2017. Thursdays jump in the bank stocks might be signaling a rotation back into financials. A rotation back into banks could be drive by two factors. First, the U.S. House of Representatives approved this week the Financial Choice Act, a bill that aims at dismantling major aspects of Dodd-Frank. Second, the increasingly hawkish tone from the Federal Reserve (signaling more rate highs) will be another positive catalyst for bank stocks.
The retail sector has been a dog of late
.except the online retailers (see our Commentary The Death of Traditional Retailers Maybe A Bit Exaggerated). While there is no sign that the relative downtrend is reversing in retail, this is one sector to keep an eye on to confirm the continuation of the bull market.
Pharmaceuticals are another sector that has underperformed and, like banks, looks set to begin outperforming again.
The big loser in 2017 has been energy. Oil prices are unable to gain upward momentum for more than a couple weeks at a time. There are no signals of a reversal higher in energy stocks, but the S&P 500 has managed to rise since 2014 even with energy stocks collapsing. While energy sector performance may not be needed to keep the bull market going, this sector is building up huge potential for the day West Texas oil prices finally break above the $50-$54 / barrel range.
The metals & mining sector has under-performed but looks to be forming a nice base. This is setting up to be a nice rotation play for the summer.
Small Cap stock underperform is typically associated with periods of risk-off. Seeing the Russell 2000 begin to outperform will be crucial in maintaining the bull market. Thursdays jump in the Russell 2000 (visible in the chart below), with the S&P 500 trading flat, could reinforce the bullish hypothesis over the summer months.
It almost seems to be too obvious that buying technology, and growth stocks in general, at this stage and neglecting the relatively attractive lagging sectors will be a losing strategy beyond a short-term trading horizon. Bulls should look to rotate into lagging value sectors cited above as their relative performance trends stabilize and turn up.