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Market review 23.02.05
Sector rotation and new opportunities
I try to limit these posts to just 10 charts, but there’s a lot to discuss that I’ve hit 20 today. Grab a beverage.
Last week, we looked at how defensive sectors have been lagging. Let’s expand on this more.
The chart below shows the past 3-month performance of equally-weighted US sector ETFs. These are more representative that the more popular cap-weighted SPDRs which in many cases have a ~40% allocation in just 2 stocks (eg. XLK, XLC, XLY, XLE).
Notice how consumer discretionary has had the best performance since Nov, followed by comm, tech, and materials. Defensive sectors and energy have had the worst performance. This is consistent with the early stages of a bull market (at the end of this post, I’ll discuss the typical sector rotation phases throughout the market cycle).
Another way to show the above is via the ETF leadership board:
Generally, commodities (DBA, OIL) have dropped out of the leaders region while tech (XSD, XBI, IBB) and consumer discretionary (XHB, XRT) have entered in.
What I like is how gradual this transition took place over the past few quarters. A while back, XBI and TAN emerged from the laggards while DBA fell out of the leaders. Here’s the staggered bottom in tech specifically:
More recently, OIL has joined DBA and UNG in the penalty box. Now XLE is starting to drop out of the leaders. Overall, commodities are pressing 52-week lows and looking vulnerable for the next leg down:
Add to this the strong jobs report on Friday, and we’re seeing the narrative shift from “A recession is certain” to “The economy & consumer are strong, and inflation has been tamed.” Thus, consumer discretionary and tech have been shining. Financials and industrials look very attractive too.
I’ll cover all these sectors today and assess new long opportunities.
The most popular ETF here is the cap-weighted XLY, which is 26% in AMZN and 13% in TSLA. These stocks have done well so far this year. But there’s a lot more to it than these two big names.
Like industrials, consumer discretionary is a very diverse sector. Of course, it includes retail stores, restaurants, travel, and casinos. But it also includes e-commerce (“tech”), autos & auto parts (“industrials”), and home builders (“real estate”).
Homebuilders have been all the talk this week. Recall that the Dow Homebuilders Index hit major long-term support last year. Even though I posted this chart many times as support was being tested, I must admit that I didn’t think support would hold considering the steep mortgage rate hikes.
While I blundered that great initial entry on support, all is not lost. XHB made a big breakout this week that provides a decent entry:
A strong name within the builders is GRBK and the monthly chart shown below looks fantastic. Value investor David Einhorn has a 26% allocation to this name – his largest holding.
Below is XRT (retail ETF) making a nice breakout this week.
Also, checkout the weekly chart for EBIZ (global e-commerce ETF). It has been fuelled by recent winners such as W, SHOP, MELI and ETSY – all of which are up ~2x from last year’s lows.
One name I’m watching in this space is CPNG (a Korean e-commerce stock). It’s been basing on the weekly chart. I mention this one because it has lots of institutional ownership and is Stan Druckenmiller’s largest holding at 18%.
Last week, we looked at the breakout in XSD. Semis and broader tech had another great run during a big earnings week for the sector. The highlight was META gaining 23% (or +$95B in market cap) after the company announced a $40B increase to its buyback program.
The main themes in tech are semiconductors, IoT, and of course AI. With ChatGBT dominating discussions in recent months, it’s no surprise to see the latter becoming a hot theme much like, dare I say it, the metaverse was in ’21.
Tech likely continues to lead for a while, however, in the short-term it’s hard to add to positions to many of the names in this space - especially RIOT, MARA, PTON, and LCID which saw a 2x in just a couple weeks. Some stocks, particularly the semis, have run into resistance and can pause here. See this tweet showing examples.
The broader market remains bullish, so the question is, what else could be getting going here that we can get into? I will discuss sectors that are a little further down on the list of past 3-month top performers: financials and industrials.
More traditional areas
Recall the period from Oct 2020 to Mar 2021. Many parts of the market saw explosive rallies. Yes, this included profitless tech, crypto, and meme stocks.
But we also saw some of the more boring areas rally hard relative to the S&P 500 and then consolidate for the past 2 years. These areas now appear to be getting going again and could provide for a nice trade.
I’m talking about sectors like regional banks, industrials, materials, consumer discretionary, and broader ETFs that are concentrated in these sectors (small-caps, shareholder yield, and deep value). The chart below shows it nicely:
IJR (Small-cap 600 ETF) was up 5% this week and made a clean breakout. The top sectors in this ETF are financials (17%), industrials (17%), and consumer discretionary (14%).
IJR is also beautiful relative to SPY. How about this 20-month base breakout?
For some perspective, the forward P/E ratio for the S&P 600 small-cap index hit 25yr+ lows last year, around the same time that financials, homebuilders, and global indices hit decade+ support levels. A lot of froth was wiped off the market during the ’21-’22 bear market.
DEEP was up +6% this week and popped above 1-year resistance. This ETF is currently 29% in consumer discretionary, 22% industrials, 12% financials, and 11% materials.
SYLD Weekly. I’ve discussed this one a few times on this blog. It broke out of a 2-year base this week. This fund is 26% in consumer discretionary and 21% in financials.
While SYLD is also breaking out relative to SPY just like IJR and DEEP, it is 18% in energy, which means it could underperform these other 2 ETFs.
XLF (broad financials ETF) is very similar to homebuilders in that it (a) retested a major long-term support level last year …
… and (b), made a breakout this week:
Last year, Insurance (IAK) was a leader and regional banks (KRE) were the laggard. Since Dec, that performance gap has been closing, with KRE showing nice strength while insurance has been flat.
KRE had a strong week, and its chart looks great. I bet many saw a “Head and Shoulder” top on this chart - when the market doesn’t go in the direction you think, the opposite move can be a good one.
The past year has been a masterclass in sector rotation.
During last year’s bear market, defensive areas (health care, utilities, and staples) outperformed. But since the Oct lows in broad US indices, these sectors are now underperforming.
Consumer discretionary and tech have been the leaders in this new bull market, but financials and industrials also look great right here. Meanwhile, commodities (agriculture, energy) look weak.
It’s neat how all this fits into the standard sector rotation playbook:
There’s also a more rigorous chart that I really like from Fidelity at the bottom of this link. Look at which sectors consistently outperform and underperform during this early phase of a bull market.
We have new trends in place, and they can persist for a while. However, much like how the equity market hit major long-term supports last year with low sentiment, we could see the same happen for energy stocks down the road – when it’s their turn in the sector rotation playbook.
I’ll leave you with these tweets to reflect on:
That’s all for this week! If you found this post useful, please give it a like and share. Thanks for reading.
Important Disclaimer: This blog is for educational purposes only. I am not a financial advisor and nothing I post is investment advice. The securities I discuss are considered highly risky so do your own due diligence.