If you are a regular reader of Money and Markets, you know I’m a big fan of technical analysis when it comes to investing. I find it an indispensible tool for tracking financial market trends. In fact I just wrote about a simple yet effective trend-following indicator (see: Why the Trend is Still Your Friend).
Today I’d like to expand on this topic by taking a closer look, not at the overall market, but at relative price trends within the S&P 500. Recently, I’ve noticed a potential shift in trend that could influence your asset allocation toward stocks.
The S&P 500 has climbed the proverbial wall-of-worry this year, up an impressive 13.9 percent year-to-date through the end of last week. Most investors would consider that a great YEAR for stocks … and we’re only in the second week of May!
|Tracking relative price trends within the S&P 500 can help you see a possible shift in trend.|
But one potential red-flag I, and many other market watchers, have noticed in recent weeks is the strong performance by defensive sectors, including: Healthcare, up 20 percent year-to-date, and Consumer staples, up 18.9 percent!
Traditionally, these defensive sectors tend to show leadership closer to the end of a stock market advance, warning of a potential downturn ahead. Meanwhile, cyclical sectors including technology and energy stocks and especially basic materials have lagged in performance (see chart below).
Perhaps these differences in relative strength among the sectors can be explained by the current slow-growth environment in the world economy. There’s not a lot of global growth to go around. And aside from emerging markets, the U.S. is one of the few bright spots.
In such a climate, it makes sense why stock investors might be attracted to defensive stocks and sectors. Another factor could be dividends. Consumer staples and healthcare stocks offer attractive dividend payouts, in some cases higher than the yield offered on government and corporate bonds. For yield-starved investors, this is an important factor.
Still, for this stock market’s uptrend to continue, I would expect this rally to broaden out to more economically sensitive sectors, which have lagged so far this year.
But we may be in store for a reversal in sector relative strength, if recent performance is any indication. The stock market may have reached an inflection point, as cyclical sectors are beginning to outperform defensives.
Last week alone, the Technology sector soared 4.66 percent higher, although the sector is second-to-last in performance this year.
Energy stocks in the S&P 500 were up 2.95 percent last week, the second-best performing sector, but energy is up just 10.8 percent year to date, behind all but three other sectors.
As you can see in the chart above, with earnings season now winding down, technology is the best performing sector over the last two weeks, with energy in second-place. In fact, the top-six in performance are cyclical sectors, while Healthcare is the worst performing group, down 1 percent.
I believe this shift in sector relative strength has a lot to do with first-quarter earnings results. In fact, 79 percent of companies in the energy sector have reported first quarter earnings ahead of estimates, while 71 percent have beaten top-line sales expectations. That’s the best combined “beat rate” (when both sales and profits beat estimates) in the S&P 500 this quarter!
There is an easy way to keep tabs on relative strength between cyclical and defensive stocks, and see at a glance which is leading the performance derby.
The Morgan Stanley Cyclical Index (CYC) includes a diversified basket of 30 U.S. stocks from economically-sensitive sectors of the economy, including 3M Co. (MMM), Caterpillar (CAT), and Dow Chemical (DOW) among others.
Meanwhile, the Morgan Stanley Consumer Index (CMR) includes stable, consumer focused stocks; most of them from the healthcare and consumer staples sectors including: General Mills (GIS), Johnson & Johnson (JNJ), and Merck (MRK).
Using technical analysis software (free at StockCharts.com) you can graph the ratio of CYC relative to CMR for a quick-and-easy gauge of how cyclical stocks are performing relative to defensive stocks.
As you can see above, cyclicals outperformed in 2012, but there was a definite shift in relative performance in favor of defensive stocks beginning this January. Since April however, cyclical stocks (especially energy and technology) are once again outperforming.
Investing is always a game of relative performance. When making asset allocation decisions for your portfolio, you must always compare one asset class against another … or one stock’s performance relative to others. That’s why it’s so important to keep tabs on trends in relative performance.