Big Four Sector Leadership
When we first began writing about sector rotation some twenty years ago, we often used a “Big Three” concept. At the time, the three largest sectors were Technology, Financials, and Health Care. Our theory was that any “Bull Market” worthy of the name needed at least two of the Big Three involved as leaders. Times change, and Consumer Discretionary has joined the ranks of major sectors. Additionally, strength in that sector is also consistent with bull market conditions. The new Big Four presently comprise about 58% of U.S. stock market capitalization, and all four members are currently supplying market leadership.
Conceptually, Health Care is the odd man out because it is often considered “defensive” and tends to outperform in weak markets. While that is certainly true, anyone who bears even a limited part of their own health care costs can attest it is also a growth sector. Sector leadership can change quickly, of course. Current conditions may end tomorrow, but they may also endure for another year.
To the extent this bull market is driven by loose Fed policy, Ben Bernanke’s Monday comments definitely indicated more of the same. The ongoing “Operation Twist” bond-buying program is scheduled to end in June. PIMCO head Bill Gross today told Bloomberg News he thinks the Fed will shift its focus to propping up mortgage bonds.
Today the ten-year Treasury yield ended just below 2.20%, after trading as high as 2.40% last week. The five-year note auction drew the least demand since last August, and the five-year yield is a measly 1.03%. The Fed remains a major buyer. With short-term rates set to stay near zero, attention is now shifting to longer-term bonds. Weak commodity prices – with crude oil being the main exception – indicate investors still have little fear of inflation.
Following a one-week break, Technology again holds the top rank in our table. The Financial Services sector is not far behind, however, so the two are probably best regarded as co-leaders for now. Consumer Discretionary holds a solid third-place position. Health Care – which last week we mentioned as “middle of the pack” – moved up to fourth place in an attempt to escape the pack. Industrials slipped to #5. Consumer Staples, Telecommunications, and Materials are all lagging the market. Energy has shed most of its recent momentum and is now on the verge of replacing Utilities in the last-place spot.
We are currently in a market of extremes, at least according to today’s Style rankings. Micro Cap – the very smallest stocks – are in first place with biggest-of-the-big Mega Cap right behind at #2. Exactly what this anomaly means is unclear, but we doubt it will continue for long. The Growth/Value axis has a little more clarity. Investors clearly prefer Growth stocks, with all three categories in the top half of the rankings. Meanwhile the three Value groups are huddled together at the bottom. The overall impression is that stock investors are embracing risk, and for some reason they have redefined Mega Cap as risk-oriented instead of the semi-defensive role it once held.
Relative positions in the Global categories was remarkably unchanged since last week. The top five stayed the same, as did the bottom three. The only difference now is that Latin America jumped two notches from #8 to #6, putting itself ahead of the United Kingdom and Emerging Markets benchmarks. The U.S. widened its lead over second-place Europe even as the Euro currency neared its highest level against the dollar since early December. Within Europe, we see Germany and a few northern peers showing better results than Italy, Spain, and Greece. In Japan, the Nikkei index held above 10,000 and helped improve sentiment. Resource-rich Canada and Pacific ex-Japan continued to lag amid weaker commodity prices. China, still in last place, weakened further. ETFs covering China are beginning to enter long-term downtrend status. As we have seen in the past, however, Chinese stocks can turn on a dime.
“I have a sense that they’ll [the Fed] continue with the Operation Twist, but not necessarily in terms of buying longer-term bonds and selling shorter dated Treasuries…I think [Bernanke] will try to do is Twist in the mortgage market.”
PIMCO co-CIO Bill Gross, March 28, 2012
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