THE STARTING ROTATION
Spring is upon us and, thankfully, baseball is just around the corner. Major League Baseball clubs are currently preparing for the season at their respective spring training facilities in Florida and Arizona. As always, one of the biggest questions each team faces is what their starting pitching rotation will look like come opening day. Pitching comes at a premium in baseball; name another profession where you work once or twice a week and can make $30 million a year. Like the saying goes, "it's good work if you can get it." Success in baseball ultimately begins with starting pitching.
The market has relied on its aces - technology and healthcare stocks - to propel its most recent bull run. But what happens when your starters run out of gas? If you're Grady Little, you stick with them (forgive the dated reference but it still brings a smile to my face). Recently, we have begun to see signs of sector rotation as long dormant areas of the equity markets have begun to pick up some slack.
Like any portfolio of risky assets, an index will will be less risky than its most volatile components and, most of the time, more risky than its least volatile components. The aggregate performance of a properly diversified portfolio - let alone a dynamically diversified portfolio* - will benefit from various sources of return and, more importantly, various sources of risk. The point of diversification is to account for the fluctuations in the performance of component assets... these fluctuations are what I refer to as sector rotation.
* http://tancockstradingblog.blogspot.com/2015/09/creating-vix-signal-to-manage-asset.html
Since the financial crisis, healthcare (especially biotech) and technology sectors have been the primary performance drivers behind the broad market rally which has seen the S&P 500 increase by more than 150% from its lows in 2009. Pharmaceuticals and technology sectors have run up more than 300% and 200% respectively over that same time period. Biotech is just one component of the healthcare sector, but the sheer scale of its fluctuations have been remarkable and especially noteworthy.
Through June of last year, biotech and technology were outperforming the broad markets by staggering margins:
However, as markets have turned over since the summer, healthcare and tech have been hit especially hard. Last September, I wrote about the upcoming troubles in the biotech sector in a post titled 'The Biotech Selloff is Just Getting Started and What That Means for the Broader Market":
http://tancockstradingblog.blogspot.com/2015/09/the-biotech-selloff-is-just-getting.html
Since then, the sector has continued to falter. In fact, from March of 2009 through June of 2015, biotech as a sector outpaced the S&P by a staggering 17% on an annualized basis. However, it has lagged the slumping index by almost 30% since.
Similarly, technology has also been strong since the financial crisis. From March of 2009 through June of last year, tech shares - as measured by the Nasdaq 100 - have outperformed the broader markets by 8% on an annualized basis. However, since June, the sector has fallen 350bp more than the S&P.
CALL TO THE BULLPEN
When starting pitchers start to tire out in baseball, teams carry a reserve of relief pitchers to pick up the slack. The problem here is that relief pitchers tend to be weaker performers than starters.
As the market's star performers start to tire, it will need its own relievers to carry the weight for a while. Currently, energy and consumer related sectors have helped to stop the bleeding. The problem is that these newly strong performers are disproportionately underweight in the S&P. Energy, consumer discretionary, consumer staples, materials, telecommunications and utilities all together only make up 39% of the benchmark index. Meanwhile, a few key weak sectors carry far more weight; healthcare, financials and technology alone constitute more than half of the index.
This latest rally in the S&P has been almost a carbon copy of last September's rally. The index will have to solidify its position above the 50 day moving average for the specter of further volatility to diminish though.
Time alone will tell if that happens but here's where we are now:
A MURDERER'S ROW OF GLOBAL ECONOMIC AND GEOPOLITICAL FACTORS ARE COMING UP TO BAT
There are currently a host of global economic and geopolitical factors standing in the way of this recovery. China's growth prospects and interventionist policies remain areas of concern. What will be the long term impacts of the nation's raid on the piggy bank as it continues to dump its hoard of U.S. Treasuries to prop up financial markets? Divergent global monetary policies present another area of potential conflict... IMF Chairwoman, Christine Lagarde, has repeatedly warned of the unintended consequences of a strong U.S. Dollar. A possible UK exit from the European Union has brought added political uncertainty to Europe. Not to be outdone, the U.S. presidential election posits some truly frightening leadership scenarios for the West to boot.
Spring is upon us and, thankfully, baseball is just around the corner. Major League Baseball clubs are currently preparing for the season at their respective spring training facilities in Florida and Arizona. As always, one of the biggest questions each team faces is what their starting pitching rotation will look like come opening day. Pitching comes at a premium in baseball; name another profession where you work once or twice a week and can make $30 million a year. Like the saying goes, "it's good work if you can get it." Success in baseball ultimately begins with starting pitching.
The market has relied on its aces - technology and healthcare stocks - to propel its most recent bull run. But what happens when your starters run out of gas? If you're Grady Little, you stick with them (forgive the dated reference but it still brings a smile to my face). Recently, we have begun to see signs of sector rotation as long dormant areas of the equity markets have begun to pick up some slack.
Like any portfolio of risky assets, an index will will be less risky than its most volatile components and, most of the time, more risky than its least volatile components. The aggregate performance of a properly diversified portfolio - let alone a dynamically diversified portfolio* - will benefit from various sources of return and, more importantly, various sources of risk. The point of diversification is to account for the fluctuations in the performance of component assets... these fluctuations are what I refer to as sector rotation.
* http://tancockstradingblog.blogspot.com/2015/09/creating-vix-signal-to-manage-asset.html
Since the financial crisis, healthcare (especially biotech) and technology sectors have been the primary performance drivers behind the broad market rally which has seen the S&P 500 increase by more than 150% from its lows in 2009. Pharmaceuticals and technology sectors have run up more than 300% and 200% respectively over that same time period. Biotech is just one component of the healthcare sector, but the sheer scale of its fluctuations have been remarkable and especially noteworthy.
Through June of last year, biotech and technology were outperforming the broad markets by staggering margins:
However, as markets have turned over since the summer, healthcare and tech have been hit especially hard. Last September, I wrote about the upcoming troubles in the biotech sector in a post titled 'The Biotech Selloff is Just Getting Started and What That Means for the Broader Market":
http://tancockstradingblog.blogspot.com/2015/09/the-biotech-selloff-is-just-getting.html
Since then, the sector has continued to falter. In fact, from March of 2009 through June of 2015, biotech as a sector outpaced the S&P by a staggering 17% on an annualized basis. However, it has lagged the slumping index by almost 30% since.
Similarly, technology has also been strong since the financial crisis. From March of 2009 through June of last year, tech shares - as measured by the Nasdaq 100 - have outperformed the broader markets by 8% on an annualized basis. However, since June, the sector has fallen 350bp more than the S&P.
CALL TO THE BULLPEN
When starting pitchers start to tire out in baseball, teams carry a reserve of relief pitchers to pick up the slack. The problem here is that relief pitchers tend to be weaker performers than starters.
As the market's star performers start to tire, it will need its own relievers to carry the weight for a while. Currently, energy and consumer related sectors have helped to stop the bleeding. The problem is that these newly strong performers are disproportionately underweight in the S&P. Energy, consumer discretionary, consumer staples, materials, telecommunications and utilities all together only make up 39% of the benchmark index. Meanwhile, a few key weak sectors carry far more weight; healthcare, financials and technology alone constitute more than half of the index.
This latest rally in the S&P has been almost a carbon copy of last September's rally. The index will have to solidify its position above the 50 day moving average for the specter of further volatility to diminish though.
Time alone will tell if that happens but here's where we are now:
A MURDERER'S ROW OF GLOBAL ECONOMIC AND GEOPOLITICAL FACTORS ARE COMING UP TO BAT
There are currently a host of global economic and geopolitical factors standing in the way of this recovery. China's growth prospects and interventionist policies remain areas of concern. What will be the long term impacts of the nation's raid on the piggy bank as it continues to dump its hoard of U.S. Treasuries to prop up financial markets? Divergent global monetary policies present another area of potential conflict... IMF Chairwoman, Christine Lagarde, has repeatedly warned of the unintended consequences of a strong U.S. Dollar. A possible UK exit from the European Union has brought added political uncertainty to Europe. Not to be outdone, the U.S. presidential election posits some truly frightening leadership scenarios for the West to boot.
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