Look at all these sector rotations! Welcome to the new regime
Recently we've seen a significant "rotation" in markets toward large cap tech and defensives, and away from small caps, financials, and transportation. In this post, I will describe the rotation through a series of charts, and I will also suggest some explanations for what's going on. The long and short of it is that I think we've just witnessed a regime change, and markets are going to look very different for the rest of the year.
What's up: ecommerce, software, automation
After a long period of underperformance early this year, the software sector made a bullish trendline break vs. the S&P 500 at the end of May, and has been outperforming ever since:
Likewise the Global X Robotics & Artificial Intelligence ETF:
And the Amplify Online Retail ETF:
Note that the online retail ETF is outperforming despite recent weak retail sales numbers.
What's down: airlines, retail, materials
While tech names have been breaking out upwards, we've seen downward breakouts in several other sectors that outperformed early this year. This includes most of the winners of the "reopening" trade, including airlines:
The "consumer discretionary" or retail sector has also rolled over, obviously with the exception of ecommerce:
As retail rolls over, we're also seeing some very bearish action in the materials sector. In addition to a sharp selloff in lumber, we also saw iron ore and gold take big dumps in the last few days. The materials sector has broken its uptrend relative to the S&P:
What's going on: weak demand and the Delta variant
Partly tech may be outperforming because of falling bond yields. Tech has been inversely correlated with interest rates since early this year. But I think a couple other factors are also in play. The economic data lately have been very disappointing, with weak retail sales, weak durable goods orders, and weak housing starts. A lot of consumers now say they are hesitant to buy a house, and initial unemployment claims ticked up significantly this week. The ECRI leading weekly index has been in a downward slide since mid-March.
All of this points to weakening consumer demand, which I think is why you see the retail and materials sectors falling so hard. The drop-off in demand is partly due to inflated prices, and partly due to the elimination of expanded unemployment benefits. Having already spent their stimulus checks, consumers now simply have less money to spend.
There's another factor, too, which is Covid-19 variants. The variant known as "Delta" has been ravaging India and spreading fast in the rest of the world. This variant is highly contagious and has been described as "Covid-19 on steroids." Meanwhile, the vaccine-resistant variants known as "Alpha" and "Beta" have been spreading in Europe and the United States. Alpha is now the predominant strain in the US, having increased from 12% of cases to 37% of cases in the last 4 weeks. With variants a growing threat, it's possible that some traders are hedging against a "reclosing" economy, or at least the possibility that consumers might travel less.
Another noteworthy shift: bonds over financials
Also note that financials have broken their relative uptrend, with a big drop today:
The selloff in financials was a reaction to the upward breakout in bonds:
It appears that we're headed into a new cycle of monetary stimulus and low interest rates, which means lower yields for banks.
Oddly, the US dollar also broke out upward today. I'm unsure what that's about, or how it fits in with the price action in bonds. Normally higher bonds and higher inflation would be bearish for the dollar.
What's threatened: aerospace, energy, and transportation
The aerospace, energy, and transportation sectors are so far still in an uptrend, although all three exhibited some weakness today.
You'd think that aerospace would fall along with airlines, but remember that the aerospace sector also includes defense, and we are increasingly under threat from China.
The transportation sector includes passenger travel like airlines, but it also includes shipping companies like UPS and FedEx. So ecommerce strength may offer some support, but this could still fall out of its uptrend soon.
The energy sector trades somewhat in sympathy with transportation, so transportation weakness could bode ill for energy. Energy is also inversely correlated with the US dollar, so today's upward dollar breakout could cause pain for energy. However, this sector is currently being supported by oil shortages and hype around the possibility that oil will reach 100/barrel.
Keep an eye on defensives, real estate, and biotech
Investors seem to be getting more and more defensive. That includes taking refuge in large, high-quality names. Large caps underperformed early this year, but that has changed in June, with the cap-weighted S&P 500 having broken its downtrend relative to the equal-weighted index:
It also looks like several defensive sectors are basing relative to the index. The relatively undervalued communications sector may benefit from the bipartisan infrastructure bill that's now near to passing in the Senate:
We're also seeing consumer staples, utilities, and healthcare find some support, though no big upward breakouts yet:
Surprisingly, real estate and biotech are also both seeing bullish movement relative to the S&P 500, so these are sectors to watch. Both are relatively undervalued due to having underperformed for a long time:
What's up: ecommerce, software, automation
After a long period of underperformance early this year, the software sector made a bullish trendline break vs. the S&P 500 at the end of May, and has been outperforming ever since:
Likewise the Global X Robotics & Artificial Intelligence ETF:
And the Amplify Online Retail ETF:
Note that the online retail ETF is outperforming despite recent weak retail sales numbers.
What's down: airlines, retail, materials
While tech names have been breaking out upwards, we've seen downward breakouts in several other sectors that outperformed early this year. This includes most of the winners of the "reopening" trade, including airlines:
The "consumer discretionary" or retail sector has also rolled over, obviously with the exception of ecommerce:
As retail rolls over, we're also seeing some very bearish action in the materials sector. In addition to a sharp selloff in lumber, we also saw iron ore and gold take big dumps in the last few days. The materials sector has broken its uptrend relative to the S&P:
What's going on: weak demand and the Delta variant
Partly tech may be outperforming because of falling bond yields. Tech has been inversely correlated with interest rates since early this year. But I think a couple other factors are also in play. The economic data lately have been very disappointing, with weak retail sales, weak durable goods orders, and weak housing starts. A lot of consumers now say they are hesitant to buy a house, and initial unemployment claims ticked up significantly this week. The ECRI leading weekly index has been in a downward slide since mid-March.
All of this points to weakening consumer demand, which I think is why you see the retail and materials sectors falling so hard. The drop-off in demand is partly due to inflated prices, and partly due to the elimination of expanded unemployment benefits. Having already spent their stimulus checks, consumers now simply have less money to spend.
There's another factor, too, which is Covid-19 variants. The variant known as "Delta" has been ravaging India and spreading fast in the rest of the world. This variant is highly contagious and has been described as "Covid-19 on steroids." Meanwhile, the vaccine-resistant variants known as "Alpha" and "Beta" have been spreading in Europe and the United States. Alpha is now the predominant strain in the US, having increased from 12% of cases to 37% of cases in the last 4 weeks. With variants a growing threat, it's possible that some traders are hedging against a "reclosing" economy, or at least the possibility that consumers might travel less.
Another noteworthy shift: bonds over financials
Also note that financials have broken their relative uptrend, with a big drop today:
The selloff in financials was a reaction to the upward breakout in bonds:
It appears that we're headed into a new cycle of monetary stimulus and low interest rates, which means lower yields for banks.
Oddly, the US dollar also broke out upward today. I'm unsure what that's about, or how it fits in with the price action in bonds. Normally higher bonds and higher inflation would be bearish for the dollar.
What's threatened: aerospace, energy, and transportation
The aerospace, energy, and transportation sectors are so far still in an uptrend, although all three exhibited some weakness today.
You'd think that aerospace would fall along with airlines, but remember that the aerospace sector also includes defense, and we are increasingly under threat from China.
The transportation sector includes passenger travel like airlines, but it also includes shipping companies like UPS and FedEx. So ecommerce strength may offer some support, but this could still fall out of its uptrend soon.
The energy sector trades somewhat in sympathy with transportation, so transportation weakness could bode ill for energy. Energy is also inversely correlated with the US dollar, so today's upward dollar breakout could cause pain for energy. However, this sector is currently being supported by oil shortages and hype around the possibility that oil will reach 100/barrel.
Keep an eye on defensives, real estate, and biotech
Investors seem to be getting more and more defensive. That includes taking refuge in large, high-quality names. Large caps underperformed early this year, but that has changed in June, with the cap-weighted S&P 500 having broken its downtrend relative to the equal-weighted index:
It also looks like several defensive sectors are basing relative to the index. The relatively undervalued communications sector may benefit from the bipartisan infrastructure bill that's now near to passing in the Senate:
We're also seeing consumer staples, utilities, and healthcare find some support, though no big upward breakouts yet:
Surprisingly, real estate and biotech are also both seeing bullish movement relative to the S&P 500, so these are sectors to watch. Both are relatively undervalued due to having underperformed for a long time:
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