Rotation or Head Fake?

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June 2, 2020

To watch/listen to this week’s article click here.

I know most of us look at the major indexes like the Dow Jones Industrial Average (Dow) and/or the S&P 500 and look at the direction (up or down) and by how much, and then discern that if it’s up that’s a good thing across the board. When I’m not in front of the computer, I tend to do the same thing. Well firstly, forget the Dow, it’s only made up of 30 stocks, and in my opinion has many flaws which I will not go into, if for no other reason than to keep you awake. Let’s just say that the given the Dow’s limited spread throughout all the sectors of the U.S. based companies, it has an overweight to the cyclical sectors, which I will explain below.

You could be forgiven in thinking that the Dow and the S&P 500 should return roughly the same return, given they are both classified as Large Cap U.S. Based Companies. As you can see, the difference is quite large.

The S&P 500 is a good benchmark to follow, as it gives you enough depth and spread to capture moves in all sectors of the market. Although it is “market capped”, meaning the bigger the company, the more impact it will have on the index returns. I’m not a huge proponent of this, however I try not to argue against something when it’s been right.

The past few years, the bigger companies (the ones that also have a bigger impact on the indexes) have outperformed the overall market. This outperformance dates back to when President Trump was elected.

Why would I tell you all this? Well last week, (up until the time I’m writing this on Thursday morning) the major moves we had seen in the indexes came from the sectors of the market that have lagged the most. Since the most recent market highs on February 19th of this year, the market has been led by the “find a cure/work from home trade”…Health Care/Technology. This past week it has been Financials and Industrials. So when you look at the headlines and see the markets up, don’t fall into the trap of believing that it’s clear sailing. We need to look at the radar and see what’s giving you this nice ride and attempt to determine how long it will last.

Cyclical Sectors are those that are closely related to the overall economy. Generally, when an economy is growing, the cyclicals will be the beneficiaries as they provide the goods and services that will profit from that growth. In contrast you have non-cyclicals that are more defensive in nature and serve a greater purpose in everyday life.

Here’s a quick breakdown:

The last sector I have not put in either box is Communication Services. This sector combined a few sub sectors in the past few years that I feel has made it a combination of both. This sector now combines the large wireless carriers with the streaming movie providers and social media platforms. There about as far apart in the way they operate as you can get, but still considered the same sector.

The question I like most from people who manage money is, “Is this the rotation to keep the market moving higher or a head fake?” I’m of the belief for a while that the market cannot sustain a long rally without the cyclical sectors contributing and/or leading, but my better self is telling me that if I’m optimistic, we get back to 85% of our economy operating in 3-6 months, then I find it hard to believe in the cyclicals for very long.

I’m very in tune with head fakes… especially now after watching what was probably one of the best sports documentaries I’ve seen….The Last Dance on Netflix, a documentary about Michael Jordan’s career with the Chicago Bulls. I would encourage any sports lover to watch it. Jordan had moves that were superhuman, although what I took away from it was how competitiveness drove him to greatness, and his head fake.

We have been given a couple of head fakes before. Below I give you the S&P 500 Growth vs. S&P 500 Value. The chart represents how far they are from their all-time highs. As you’ll see, we have had Value (that has been a longtime underperformer) pop its head back to even since the market low a couple of times, only to give us what Jordan has in the past. (23 is Jordan’s number in case you don’t know.)

So for now, we are still victims of the technical, meaning while volatility is above average, I pay the charts a lot of respect. Volatility measured by the S&P 500 Volatility Index, commonly known as the VIX, although down from the extremes is still above long-term trend lines. Reading above 20 keeps me paying particular attention to the trends.

This most recent move has the market right at its 200-day moving average. The technicians will tell you that this is a significant area to pay attention to. If the market can hold the 200-day moving forward the next 30 days or so, then conventional wisdom will tell you that the weather forecast is clear. However, if we are unable to hold it that, then expect a wild ride.

For the short term, I’m still in the camp of a sideways movement. I showed you a chart last week but have updated it through today to show you the comparison between the 2009 rebound and what we are seeing now. More importantly, what the next 40 days did. I am still a strong advocate that the risk outweighs the reward till earnings start rolling around again in mid-July.

Lots of charts this week, I know. Hope to get back to some pretty pictures again next week. Hopefully of a successful launch from my backyard. With that, here’s the buy/sell.

Mick Graham, CPM®, AIF®

Financial Advisor/Branch Manager Raymond James Melbourne, FL

The foregoing information has been obtained from sources considered to be reliable, but we do not guarantee that it is accurate or complete, it is not a statement of all available data necessary for making an investment decision, and it does not constitute a recommendation. Any opinions are those of Mick Graham and not necessarily those of Raymond James.

All charts are for illustration purposes only. The Dow Jones Industrial Average (DJIA), commonly known as “The Dow” is an index representing 30 stock of companies maintained and reviewed by the editors of the Wall Street Journal. The S&P 500 is an unmanaged index of 500 widely held stocks that is generally considered representative of the U.S. stock market. Keep in mind that individuals cannot invest directly in any index, and index performance does not include transaction costs or other fees, which will affect actual investment performance. Individual investor’s results will vary. Past performance does not guarantee future results.

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