Sector rotation is the lifeblood of a bull market. You hear me say it all the time.
But what does that even mean? What is the sector rotation that we’re looking for?
In my experience, this is one of the most important characteristics of bull and bear markets: Who are the sector leaders?
Signs of Health
During healthy market environments, where investors are mostly being rewarded for owning stocks, the more offensive groups tend to be the leaders.
These groups include things like Financials, Industrials, Technology, and Consumer Discretionary.
- We don’t have bull markets without financials.
- Industrials historically have the highest correlation with the S&P 500 of all the official sectors.
- Technology has been a leader and outperformed on almost every bull market over the past 100 years.
- The consumer accounts for 70% of the U.S. economy.
You can make a solid argument that any of these offensive groups are the most important to the direction of the primary trend.
When these stocks are the leaders, it’s probably not a bear market.
Now, on the more defensive side, you tend to hear about sectors like Utilities or Healthcare, maybe even Real Estate.
But in my experience, THE defensive sector is the Consumer Staples. You’ll even see certain data providers actually label them “Consumer Defensives.”
This sector underperforming is a classic example of the type of sector rotation we’re looking for in bull markets: out of the Staples and into the offensive groups.
In case you’re wondering which type of environment we’re in right now, here’s the Consumer Staples sector relative to the S&P 500 hitting new all-time lows:
During healthy markets, this line tends to go down.
Currently, the line has never been more down.
Where’s the Risk?
We’re constantly talking about what could possibly happen to derail this bull market and lead to a more corrective period, maybe even a bear market.
Look no further than the chart above, the ratio chart between the Consumer Staples and the S&P 500.
If there’s stress in the market and stocks are under pressure, look for strength in Staples relative to everything else.
Keep that in mind if/when you see Staples start to outperform.
That hasn’t happened yet. The most defensive group just closed at its lowest levels ever relative to the S&P 500.
That’s the type of sector rotation you expect to see in a healthy market environment.
And that’s exactly what you’re seeing today.
Stay sharp,
JC Parets, CMT
Founder, TrendLabs