Last year was all about FAANGs and technology-based stay-at-home stocks as these names dominated the marketplace. Growth stocks outperformed value stocks by one of the greatest discrepancies in decades and by the largest dichotomy since the dot-com era of 1999-2000.
The COVID-19 pandemic has forever changed our lives, influencing how we live, work, interact, spend, and invest. The pandemic may have accelerated many of the technology trends that would have happened anyway. But it has also created excessive buying in many of the growth-related names. The structural stay-at-home theme is far from over, at least from a long-term structural perspective. Nonetheless, investors continue to debate the significance of the reflation/value trade and the Technology/growth call.
Here is the timeline of the sector rotations based on SCTR updates this past year.
Year-end 2020 – Consumer Discretionary, Industrials, Technology, and Financials
Toward the year-end, 11/23/20, a screen of the top 100 SCTR list shows a shift in buying toward economically sensitive sectors as favorable results from the Covid-19 vaccine gave investors hope for an impending economic recovery. Investors funded their purchase of the reopening stocks by selling the gains incurred from the stay-at-home plays. On 11/23/20, a quick review of the top 100 large-cap list ranked by SCTR scores confirmed economically sensitive sectors as they dominated the list. For instance, the largest concentration of stocks from the top 100 SCTR list were Consumer Discretionary (26 names), Industrials (21), Technology (16), and Financials (9).
Early 2021 – Consumer Discretionary, Financials, Energy, Technology, and Industrials
On 2/23/21, another SCTR study on the top 100 technical ranked names shows improving economic conditions led to investors favoring the reflation sectors (i.e., Consumer Discretionary and Industrials). However, two new emerging themes developed – rising interest rates (Financials) and rising inflation (Energy). The top 100 SCTR list on 2/23/21 showed two S&P sectors dominating half of the list – Consumer Discretionary (28 stocks) and Financials (25 Financials).
It is reasonable to expect Consumer Discretionary stocks to outperform because of the expectation of the reopening of the economy. In the 11/23/20 study, only 9 S&P Financial names made it to the 100 SCTR lists. The 2/23/21 update shows the financial sector moving into the second largest concentration of stocks occupying the top 100 SCTR list. Higher interest rates and the rotation from growth to value would help to explain the increased interests in the Financial Sector.
Energy (12), Technology (11), and Industrials (10) accounted for another 33 names within the top 100 SCTR list. Also, within the top 20 SCTR list were 8 Consumer Discretionary, 4 Energy, and 4 Communication Services stocks (i.e., Entertainment and Publishing).
Not a single Technology name made it to the top 20 SCTR list, suggesting investors favor the reflation trades over the structural growth sector trade, at least from a near-to-medium term perspective.
End of 1st Quarter 2021 – Financial, Consumer Discretionary, Energy, and Industrial
On 3/24/21, the top 100 SCTR list suggests investors favored the reflation trade. The S&P Financial sector assumed its leadership role with 29 stocks within the 100 SCTR list. The Consumer Discretionary slipped slightly into second place with a respectable 20 names. The Energy and Industrial sectors gain sponsorships with 13 stocks and 12 stocks, respectively. The same reflation sectors dominate the two smaller lists - top 10 and 20 SCTR lists as represented by Consumer Discretionary sector (4 stocks within the top 10 list and 7 stocks in the top 20 list), Energy (2/5), Financial (1/4), and Communication Services (2/3). Like the prior SCTR study on 2/23/21, Technology stocks failed to place on the top 10 and 20 SCTR lists. Nonetheless, a deeper dive still shows 9 Technology names within the top 100 SCTR list with 3 Semiconductors and 3 Computer Hardware stocks showing Technology leaderships.
Mid-year 2021 - Financial, Energy, Consumer Discretionary, and Technology
Financials continue to dominate on the 6/8/21 update, with 24 names within the top 100 SCTR list. Energy regained its leadership role with 18 stocks, and Consumer Discretionary rounded the top three with 14 names. Technology stocks returned to the top 4 sectors with 12 names. It closely resembles the early 2021 study (2/23/21). The top 20 SCTR list is heavily dominated by Energy stocks, with 7 out of 20 names. The remaining names consist of Technology (3), Real Estate (3), Financial (2), and Healthcare (2).
With 56% of the top 100 list concentrated in reflation stocks, this would imply the economic recovery is alive and well. However, it would also imply the easy returns may have occurred during the early stage of the expansion phase when investors favor economically sensitive names. Also, with the Industrials (9) and Materials (5) losing leadership roles and the Real Estate (9) sector improving, it would further suggest the business cycle is moving past the early expansion phase and entering the mid-cycle stage during the second half of the year.
End of Third Quarter/Beginning of Fourth Quarter
With one week before the end of the third quarter and the start of the last quarter, an update on 9/23/21 to the SCTR list shows a visible shift in sector leadership. Two sectors (i.e., Technology and Healthcare) dominate the top 100, the top 20, and the top 10 SCTR lists. Within the top 10 SCTR list, there are 5 Technology names, 4 Healthcare, and 1 Consumer Discretionary. Within the top 20 SCTR list are 12 Technology names, 5 Healthcare, and 1 Consumer Discretionary. The broader 100 SCTR list also shows 62 of the 100 top-ranked SCTR names are Technology (36), Healthcare (26), Communication Services (7), Consumer Discretionary (7), Financial (7), Energy (6), Industrial (5), Materials (3), and Real Estate (2).
Conclusion
Economic and stock market cycles can skip a phase or two. However, the typical business cycle shows a chronological and consistent procession of different sectors outperforming and underperforming at various stages of the economic cycles.
Consumer Discretionary, Financials, Industrials, Materials, Real Estate, and early-cycle Technology tend to outperform during the early phase of the business expansion cycle. During the mid-cycle expansion, typically the longest of the economic cycles, Technology, and Communication Services often excel. Economically sensitive sectors such as Consumer Discretionary and Materials relatively underperform their peers. Toward the later phase of an economic expansion, Consumer Staples, Healthcare, and Utilities tend to outperform peers.
The two sectors that are outperforming today are also two of the largest S&P 500 sectors. S&P Technology (23.56% of the SPX market-cap and +6.24% gains for the third quarter) and Healthcare (12.35% market-cap and +5.59% for the third quarter) collectively account for nearly 36% of the total S&P 500 market-cap weighting. It would explain the narrowed breadth rally for the third quarter but the healthy quarterly SPX gains of 3.52%.
In a typical economic and stock market cycle, Technology should outperform during the mid-cycle expansion phase. However, it is unusual to see the Healthcare sector, which is a late-cycle sector excelling today. Is increasing concerns of the Covid-19 delta variant worsening into the fall/winter months generating widespread interests in healthcare stocks? Or investors preparing for an economic slowdown later in the year and into 2022 and money moving into this traditionally defensive sector?
We recommend investors closely monitor the above developments, paying specific attention to Technology and Healthcare for signs of continued leadership roles. A growing economy, higher market volatility, and leaderships from Technology and Communication Services are the hallmarks of the transition from the early expansion to the mid-cycle phase. However, strengths in defensive sectors can also warn of a maturing economic expansion that is more advanced than expected.
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