We humans like to place blame. It’s one of our defense mechanisms, one of those lizard-brain behaviors we’re stuck with.
But being able to recognize those behaviors – in ourselves and others – can help us overcome them.
At TrendLabs, we’re basically trying to quantify human behavior – so we can profit from it.
And our friend Ari Wald, Head of Technical Analysis at Oppenheimer, has found a way to measure the blame game in the stock market.
He calls them “sector culprits.”
It’s a simple idea.
Every major market decline tends to have a group of stocks doing most of the damage.
Markets don’t usually wake up one morning and decide that every stock is going down together.
There’s always a culprit. Something breaks first.
Something leads to the downside. Something drags everything else with it.
Ari tends to look at this through the lens of sectors. I tend to think about it more thematically. But the underlying idea is exactly the same.
Go back to 2021. I don’t think the culprit was just “technology,” for example.
I think the culprit was more about speculative growth.
ARKK. SPACs. Unprofitable software. Chinese internet stocks. Biotechnology. Electric vehicle startups.
Anything with a story and no earnings.
That entire theme peaked together in early 2021 and then completely fell apart.
The damage was enormous. Many of those stocks lost 70%, 80%, even 90% of their value.
By the time the S&P 500 finally rolled over in 2022, the culprit had already been identified.
The speculative growth bubble had burst.
You saw the same thing happen in previous cycles. Financials, for example, were the culprits in 2008.
Every bear market has a villain. Which raises an important question:
Who’s the culprit today?
No Culprit, No Top
Ari recently shared a study that looked at the best- and worst-performing sectors over the previous 12 months.
The results were fascinating.
Since 1991, whenever the top-performing sector gained more than 40% year over year, the S&P 500 went on to generate above-average returns over the following 12 months.
Think about that for a minute.
Conventional wisdom says extreme outperformance is dangerous.
The data suggests the opposite.
Strong leadership has historically been a feature of healthy bull markets, not a warning sign.
But the more important statistic comes from the downside.
When a sector declines 20% or more over a 12-month period, the S&P 500 has historically gone on to deliver below-average returns over the following year.
That makes intuitive sense.
A sector doesn’t lose 20% of its value by accident.
Something is broken. Credit is tightening. Demand is evaporating. Investors are voting with their feet.
That’s what a culprit looks like.
Today, we don’t have one.
The current bottom-performing sector is consumer staples. And it’s roughly flat over the past year.
Flat.
Not down 20%. Not down 30%. Not down 40%.
Flat.
That’s not what “sector culprits” look like.
That’s what “healthy rotation” looks like.
Dispersion Is Not the Problem
One of the biggest concerns investors have right now is the wide dispersion beneath the surface.
Some groups are ripping higher. Others are lagging.
Some sectors are making new highs. Others are simply consolidating.
Many market participants see this as evidence that something is wrong.
I see the opposite.
Dispersion by itself isn’t bearish. In fact, dispersion is normal.
Bull markets are supposed to rotate. Leadership is supposed to rotate.
Capital is supposed to move from one area of opportunity to another.
What matters is whether a major area of the market is actually breaking down.
Right now, the evidence simply isn’t there.
The strongest sectors continue to do what strong sectors are supposed to do.
The weakest sectors aren’t acting weak enough to become genuine culprits.
That’s an important distinction.
Because when real bear markets begin, the culprit is usually obvious in hindsight.
The problem group starts deteriorating long before the indexes do.
Today, I don’t see that. Ari doesn’t see that. And the data doesn’t see that, either.
Could it change? Of course.
Markets evolve. Leadership changes. New culprits eventually emerge.
But until they do, I’m not particularly interested in arguments that the market is somehow unhealthy because some sectors are outperforming others.
That’s how bull markets work.
The real danger isn’t strong leaders. The real danger is finding a sector that’s already falling apart.
And right now, there isn’t one.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs