SECTOR RANKINGS AND WEIGHTINGS ARE STILL MARKET POSITIVE -- THE YEAR'S TOP FOUR SECTORS ACCOUNT FOR MORE THAN HALF OF THE S&P 500 -- ANOTHER 15% ARE MATCHING S&P 500 PERFORMANCE -- ENERGY IS THE BIGGEST LAGGARD BUT ACCOUNTS FOR ONLY 8% OF S&P 500
SECTOR LEADERSHIP... One of the problems facing the current stock market is that some sectors have been rising, while others have suffered large losses. Since the start of the year, for example, technology has gained nearly 14% versus a 6.7% gain for the S&P 500. Energy stocks, however, have plunged -10% this year. Industrial metal miners have lost -6% as have telecom stocks. Obviously there's a tug of war going on within the market as a whole. The question is which side is winning. To determine that, it's not just enough to count how many sectors are rising (8) and how many are falling (3) and by how much. We have to also consider how those sectors are weighted in the S&P 500. That gives us a better measure of how much the winners are impacting the S&P 500 versus the losers. Chart 1 shows the top four sector gainers since the start of year to be technology (13.7%), consumer discretionary (10.4%), healthcare (10.3%), and industrials (7.6%). All four did better than the S&P 500's gain of 6.8%. Four outperformers out of eleven sectors might not sound like much. But those four account for 57% of the S&P 500 weightings. Technology accounts for nearly 20%, healthcare (15%), cyclicals (12%), and industrials (10%). That alone gives an edge to the bulls.
Chart 1
AVERAGE SECTOR PERFORMERS... Chart 2 shows three sectors that have pretty much matched the S&P 500. This chart, however, plots the three on a "relative strength" basis versus the S&P 500. In other words, they're plotted around the S&P 500 which is the flat zero line. They include materials, utilities, and staples. The percentage numbers on the top left scale show them outperforming the S&P 500 by a slight margin (less than 1%). [In absolute terms, all three gained more than 7% versus 6.7% for the S&P 500]. The one surprise in that group is materials which includes base metals like copper and steel which have been falling. Gains in chemical stocks along with those tied to containers and packaging, however, offset those commodity losses. In addition, materials account for only 3% of the S&P 500. The same is true of utilities. Staples account for 9%. That makes for another 15% of the S&P 500 that has kept pace with the market. So far, we have 67% of the S&P 500 which is either leading it higher or matching its gains.
Chart 2
MARKET LAGGARDS... Here's where most of the problem lies. Here again, the three sector underperformers in Chart 3 are plotted "relative" to the S&P 500 which is the flat black line. The two biggest losers are energy and and telecom, with 2017 losses of -10% and -5% respectively. The scale on the upper left shows them trailing the S&P 500 by bigger margins. I've included REITs on this chart only because they've started to slip lately on a relative basis on the threat of higher interest rates (as have utilities). Although they're lagging behind the S&P by -3.2%, they're actually up 3.5% for the year. The good news is that telecom and REITs have a relatively small combined weighting of about 5%. The big problem is energy which has a larger weighting of 8% in the S&P 500.
Chart 3
FINANCIALS ARE REBOUNDING... I've saved this one for last because it's an important one. And that would be financials. The reason they're so important is that they have the second highest sector weighting in the S&P 500 (16%). That's second only to technology. Chart 5 compares the Financials SPDR (blue line) to the S&P 500 in absolute terms. There's good and bad news on the chart. The bad news is that financials have lagged behind the S&P 500 this year (2.8% versus 6.8%). The good is that they've done slightly better than the S&P since mid-April (2.7% versus 2%). Financial stocks like banks and insurers play a vital role in the functioning of the economy. It's hard to imagine a strong stock market and economy without them participating. Financials caught a bid this week after the Fed's upbeat view on the economy and a bounce in bond yields. They going to need higher interest rates to regain a leadership role. I'd put them in the neutral column for now.
Chart 4
SECTOR PERFORMANCE STILL FAVORS THE BULLS... By my count, four sectors are doing better than the S&P 500, three are matching its performance, and four are underperforming. The four leaders account for 57% of the S&P 500. The three matching sectors account for another 15%. Two of the laggards (telecom and REITs) account for only about 5%. Falling base metal shares haven't hurt the materials sector which carries a relatively small market weight (3%). In my view, the two swing votes go to financials and energy. Financials (the second biggest sector) are doing better of late and should benefit from rising rates. That leaves energy as the market's biggest problem. Energy, however, accounts for only 8% of the S&P. And while that may hold it back a bit, stronger action in most other sectors should be enough to support the market. Chart 5 plots a relative strength ratio of the Energy SPDR (XLE) divided by the S&P 500 and shows relative energy performance falling to the lowest level since the start of 2016. Its 14-day RSI line, however, is deep in oversold territory (below 30) for the second time this year. That suggests that the energy selling may be overdone.
