June 13, 2018
Scott Wren, Senior Global Equity Strategist
- Investor fears over a wide ranging number of issues resulted in our recommended sector weightings suffering in terms of performance versus the S&P 500 Index.
- However, over the last month, things appear to be back on track with the bulk of our most favored sectors outperforming.
A funny thing happened on the way to mid-year 2018: Stock volatility skyrocketed versus last year and the results were a quick 10% fall in the S&P 500 and meaningful churning in terms of sector performance. From early February through the end of April or so, investors were concerned the current cycle might come to an end as fears of a trade war, higher inflation, wage pressure hurting corporate margins, a global economic slowdown, and the Federal Reserve (Fed) picking up the pace and magnitude of rate hikes all formed what could be called a “perfect storm” of concerns.
But the question was, is, and will likely continue to be whether any of these concerns will become reality any time soon. But isn’t that always the case? Trying to handicap certain outcomes in the stock market, most of the time, can be extremely difficult. Human emotion sometimes takes over for extended periods of time as the market and the underlying fundamentals detach from each other. That is how the old quote stating “the stock market has called nine of the last five recessions” was born. We “advanced” mammals don’t always act all that advanced when our money is on the line. Fear or greed can overrule common sense and conviction more times than most of us would like to admit. Having said that, are all of the concerns listed above unlikely to occur? Is the probability that any of them become reality zero? Absolutely not, at least in this strategist’s opinion. But investing has always been a matter of assessing the probabilities and making decisions based on that analysis. That is what the Equity Strategy group had to fall back on earlier in the year when volatility picked up as fears over any number of things happening ramped up.
Our overall sector weighting recommendations worked well from the beginning of 2017 through the end of January of this year. Then things went haywire. We had been leaning toward the more cyclical sectors of the market for some time as we had most favorable recommendations on the Industrials, Consumer Discretionary, and Financials sectors anticipating better capital expenditures and consumer spending as the cycle progressed. We have also been favoring the Health Care sector. We did not want to see investors leaning toward the more defensive sectors like Utilities and Consumer Staples. But if you look at sector performance for February through April of this year, as the S&P 500 posted a negative return, a number of our favored sectors underperformed while those least-favored sectors beat the return of the index over that time frame. Was this a change in trend? Was it time to make adjustments to our sector weightings? Was the cycle coming to an end?
Not if you look at sector performance over the course of the last month. Things appear to be getting back on track. The S&P 500 has rallied and stands just a touch over 3% below the record high set in late January. In terms of sectors, three of our four most favored (Consumer Discretionary, Health Care, and Industrials) have outperformed the index while two of our three least favored (Energy and Utilities) have underperformed the index. Sector performance is turning back toward those sectors that should benefit from the macro outlook we envision. In other words, in our opinion, the February through April market action was nothing more than a head fake.
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