The S&P 500 index finished the day at 1593 setting new high, barely. Regardless, the move off the 1538 support from two weeks ago puts the index at another decision point for investors, move higher or test the current move off the recent low. In order for the upside to play out the index will need some leadership. Since the beginning of the year Healthcare (XLV) is up 19.5%, Utilities (XLU) is up 18.3%, Consumer Staples (XLP) is up 17.5%, Consumer Discretionary is up 14.8% and Financials (XLF) is up 13.7%, with the S&P 500 index up 11.7%. If we flash forward since the low on April 18th the leadership has shifted with Basic Materials (XLB) gaining 5.8%, Financials (XLF) up 4.6%, Energy (XLE) up 4.3%, Technology (XLK) up 3.9% and Telecom (IYZ) up 3.9%, with the S&P 500 index gaining 3.3%.
The modest rotation in the index is what is driving the broader indexes higher. The question is, will they continue to do so, and do they have what it will take to keep the interest of investors going forward. Earnings have hurt both the consumer staples and healthcare sectors as some stocks missed and put in perspective how rich the price to earnings of these sectors had grown. Normally defensive stocks do well in periods of slower economic growth, which they have, but they are being priced like growth stocks, and that they are not. I would expect both sectors to continue to lag the broader markets for the near term. Utilities and Industrials have underperformed the benchmark but that is expected based on the more conservative asset mix.
Looking at the leaders of late, you would have to question the realistic possibility of them leading the markets higher. Technology which is a growth sector is missing one key ingredient in the current economic outlook… growth. The 2.5% GDP isn’t exactly what technology stocks need to take on faster growth. When you factor in that 1% of the growth came from inventory build up or rebuilding, the growth outlook is on the light side currently. Basic materials needs growth globally in the emerging markets along with higher consumption of commodities. The only thing driving commodity prices currently is speculation. That is not a good barometer for the outlook in the materials sector. The ownership in the sector currently is purely a trade from our outlook. The same would go for the energy sector short term. However, the longer term prospects in the energy sector are positive when you look at the infrastructure buildout for the US to deal with their new found opportunities to become energy independent. The buildout process will benefit the energy sector longer term and for that reason offers good investments with a focus on the horizon and not as much on today.
That leaves financials and telecom to drive the short term upside for stocks. Both offer opportunities, but neither are know as growth sectors. That would lead me to the simple conclusion that the upside of the current market is limited by the facts before us. However, if logic drove market direction short term everyone would find the investment decision easy, but understanding that emotions drive the shorter term outlook and decision process, there is nothing in the way of the broad market index gaining another 5% or more in the coming months. I understand like most investors that logic wins over time, emotions will drive money short term to the fastest moving sectors that offer the most reward for the risk taken. For that reason we have to stay in front of what is moving and avoid those that are lagging.
The current leadership is where to focus or concentrate your money. Regardless of the fundamental data at this point, the trend is moving higher and that is the direction we want to be invested. We will have to maintain our discipline to understand the trend could change at any moment. That means using stops or defined exit points if the market makes a trend shift. The more extended the move becomes to the upside the greater the downside risk will be. Thus, the need to be disciplined going forward. You always take what the market gives and keep your assets protected in the event anything or everything changes. Stay focused.