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Selective Market Environment

In a challenging stock market environment, it is best to take a selective and disciplined approach to investment. Active investment strategies will play an increasingly important role in helping investors navigate a volatile and complex world. Active stock and sector selections can influence whether investors will make or lose money this year.


Sector analysis and sector rotations are far less complex and intensive than individual stock analysis. Sector selections have become a popular way for many investors to implement broad investment strategies, targeting groups of companies in specific industries and businesses.


Historically, business cycles and stock market cycles are highly correlated. Each S&P sectors have economic drivers and hence different risks. Companies in specific sectors will perform the same during the different phases of an economic cycle. The key to outperformance is to stay ahead of changing economic conditions with the right sectors, at least from a relative perspective.


With fewer sectors to select from versus individual stocks, sector selection requires less due diligence, better diversification, and fewer inherent stock-specific risks. Sector ETFs have become the overwhelming choice for many investors.


Several academic and professional studies have shown the difference in annual returns between the best and worst-performing sectors in S&P 500 Index can exceed 30% over the long term. The difference in returns of the top and bottom-performing sectors each year can impact the overall returns of an investment portfolio over time.


There has been a clear distinction between the winning and losing sectors, as evidenced by the year-to-date performances of various S&P sectors.


The shift in sector leadership has been swift and decisive toward defensive sectors (i.e., Consumer Staples and Utilities) and commodities-based sectors (i.e., Energy and Materials), select Industrials (Defense, Marine Transportation, Commercial Vehicles and Trucks), select Healthcare (Health Care Providers and Pharmaceuticals), select Financials (Reinsurance, Life Insurance, Full Line Insurance, Property & Casualty Insurance, and Insurance Brokers), and select Communication Services (Mobile Telecommunications and Fixed Line Telecommunications).


Will the above sector rotations continue into the year and next?


What are the sector and stock performance dispersions suggesting about the breadth and health of the broader stock market?


Are investors hiding in these sectors because of a flight to safety?


Are there structural changes at work accounting for the sector leaderships (i.e., Super commodities cycle, higher longer-term interest rates, long-term inflation, late stage of an economic recovery/expansion cycle, etc.)?


It has always been beneficial to understand different phases of the economic and stock market cycles. It is equally important to recognize that markets are mean-reverting.


Although the timing of the sector rotations is always challenging, a disciplined risk management strategy can help investors negotiate a choppy and volatile market environment until the next bull market trend.


The rotations on a year-to-date basis strongly suggest risk outweighs the reward, and a disciplined and active approach to investing can help.


Below are the year-to-date performances for S&P sectors and the respective industry groups. Remain patient. The market backdrop is tricky as there may be more downside risks in the marketplace. Favor the leadership areas and be selective on sectors and industry groups severely lagging their S&P peers.


Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

Source: Chart courtesy of StockCharts.com

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