Sectors Reflecting the Market Environment

by Jay Pestrichelli on September 17th, 2012

In the last 3 months the rotation from dividend paying stocks has moved to sectors positioned to outperform in this unique recovery. We say its unique because it doesn't feel like a consumer or manufacturing recovery quite yet. It feels more of an artificially stimulated and globally influenced rebound and that's just what the markets are reflecting.
The broad markets, as represented by the SPY (S&P 500), are up +9.5% since June 18th. The 4 sectors that have outperformed are Energy (XLE) +17.85%, Financials (XLF) +14.2%, Technology (XLK) +10.5%, and Materials (XLB) + 10.5%.
Energy, in our opinion, is being driven by three factors. The first is higher oil prices from the growing tensions in the Middle East. With what seems to be an acceleration of violent protests everyday last week, there seems to be a greater chance of a supply disruption. Second is the declining dollar. Simple math as a result of the Fed action is that it takes more dollars to buy a barrel. Third is the rising price of gasoline. Whether it be the drought pushing up ethanol prices or the refinery fires from July, gasoline is pressing higher.
Financials and Materials are a direct result of the Fed telegraphed willingness to play ball. As the Fed goes into the market and buys up mortgage-backed securities, the financials are able to shed off some of their risk. Despite the drag that low interest rates will have on the earnings power of the banks, the likelihood of a large bank defaulting due to the credit crisis all a thing of the past. Of course they can surely find ways to blow themselves up in other ways, right JP Morgan?. However, for XLF, currently $16.2,  its path back to pre-bubble levels of $38 has yet to begin. As risk is removed and new lending paradigms take shape, we’ll soon be able to understand what the true earnings power of the banks and lenders will be; and right now, the market thinks its going to be better than it is today.
Materials are up on the inflation trade. As the dollar and other currencies, ala Euro, get weaker, it will just take more to by physical commodities. Its that simple. China has impacted this a little as their recent stimulus plan should drive up demand a bit, but make no mistake about it, the XLB’s recent run is due to inflation concerns.
Finally there’s technology. This sector has been on a run a year now and we see no slowing. Yes, Apple is a major part of the XLK holding; about 20% as of Friday.  But as the world’s largest consumer base, the USA, continues to get more connected via mobile and the cloud, companies that provide services and applications for those mediums will also rise.
The worst 2 sectors since mid-June are the darlings of the first half of the year, Utilities (XLU) down 1.4% and Consumer Staples (XLP) up only 4% compared to the SPY up 9.5%
While typically, these sectors are considered safe havens for equity investors, the 'Fed-trade' is on and investors aren’t going to be happy with 3% dividend returns when the broad markets year-to-date are returning 20% gains.

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