Long time readers are familiar with our EdgeCharts, which rank various groups of categories by their intermediate-term momentum. They are useful in quickly assessing which Sectors, Styles, and Global Regions are currently performing the best. Identifying the worst categories in each grouping is also a straightforward process, as is the magnitude of a category’s strength or weakness. With some extra effort, trend changes and rotations are discernible.
Although we use these three methods to slice and dice the equity market into smaller and more digestible pieces, there are many other approaches. Our Sector and Style rankings are just two ways of dissecting U.S. stocks. A third technique is to create categories based on factors and strategies. Examples of factors include revenue, yield, dividend growth, volatility, and beta. Just like there are various investment funds that target different economic sectors, there are also funds that select and weight their holdings by these factors. Additional categories can be built from stocks that are spin-offs, companies engaged in stock buybacks, recent IPOs, or other criteria.
Based on these definitions, the hottest areas of the U.S. stock market currently include buybacks, spin-offs, and IPOs. This is another way to identify “what is working now.” The weakest factor-based categories include stocks with low volatility, high yield, and high dividend growth. At the beginning of the year, these three factor categories would have been at the top of the rankings. Markets also experience factor rotation along with sector and style rotation.
We can apply this methodology to bond markets also. Doing so indicates that convertible bonds are currently the category with the most strength, followed by international Treasury bonds and senior loans. Although municipal bonds have been getting much negative press lately, emerging market debt and Build America Bonds are actually performing worse.
This approach is not limited to just stock and bond categories either. Commodities can be ranked the same way, and running the analysis reveals that cocoa, cotton, and oil are performing well while natural gas, corn, and coffee are suffering. Taking a higher-level view, we can roll up these categories into asset classes. Want to know what’s working now at the asset class level? Domestic small cap stocks, foreign developed markets, and U.S. large cap stocks are where the action is. Junk bonds, commodities, and cash are holding the middle ground, while REITs and long-dated Treasury bonds have been performing poorly.
This week, there is compression in the momentum scores of the top-four Sectors, followed by steady declines in strength for the next six, and then a plunge to last place. Consumer Discretionary holds on to its first place position. Despite continued economic worries, the American consumer is apparently not “tapped out.” Health Care keeps its second place position for now, but it is receiving a serious challenge from Technology, which continues its climb out of the basement. Industrials slipped from third to fourth, although it remains among the elite performers. Materials logged the largest improvement this week, jumping from next-to-last place all the way to fifth. The category benefited from strong gains in nearly all commodity prices including gold, metals, oil, and agriculture. Financials continued its recent slide, landing in sixth place this week. Telecom also moved downward again. Real Estate is the lone Sector registering a negative trend.
Small Cap Growth held its top spot for the second week and put some distance between itself and second place Micro Cap. Small Cap Blend and Mid Cap Growth are close on the heels of Micro Cap and could easily overtake it. However, Micro Cap tends to be the Style category with the lowest correlation to the others, and it could potentially reclaim the top-ranked position. Mid Cap Value and the three Large Cap categories were in a near tie a week ago and remain so today. Large Cap Value slid from the top of this foursome to the bottom, but since all are posting nearly identical momentum scores, their relative order has little significance. Mega Cap brings up the rear again.
Europe is not just #1 this week, it now has a wide margin over the other regions and even surpasses the top-ranked Sector and Style categories. The strength of Europe helped EAFE displace the U.S. for second place with the U.S. slipping to third. China made a huge jump from eighth place to tie the U.S. for third. Economic reports out of China are indicating China’s slowdown might now be a thing of the past. Chinese stocks have been in a 6-year downtrend, and if this revived economic growth is sustainable, then stocks should go along for the ride. The U.K. and World Equity now occupy the middle ground of the Global rankings. Japan dropped a couple of notches to seventh, as volatility remains elevated. Pacific ex-Japan managed to flip from a negative to positive trend. Australia dominates the category, and it received a boost from increases in commodity prices and the Materials sector. Emerging Markets and Latin America are now the only two Global categories with negative momentum. Both are improving, and Latin America has been posting some impressive gains the past few weeks but still has much damage to repair.
“if you are in the right sector at the right time, you can make a lot of money very fast.”
Peter Lynch, the famed manager of the Magellan Fund
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