Sector Rotation in 2013 - Part 5

by Wayne Ferbert on December 17th, 2012

In parts 1 thru 4 of our Sector analysis, we used traditional valuation analysis to determine the most under-valued sectors. We established that those were the Energy and Financial sectors.
Now, to wrap up the decision on our 2013 sector concentration, let’s add one more analysis: price momentum.
We like to look at the price action in the 9 sectors we track so far in 2012. The price changes tell us something about whether the market is starting to become buyers or sellers of the sectors we like.
Here is a summary of the 2012 price action for YTD, Last 6 months, & Last 3 months:

Let’s start with the sectors we like from our Value Analysis: Financials and Energy.
The price action in Financials is very encouraging. It is the best performer so far in 2012. It is also the best 6 month performer. Despite the market being down 3% in the last 3 months, the Financials ETF is only down 1.3%. This shows that the Financials have some resilience in the face of the tough market.
Most often, being the best performer in one year would be worrisome going in to the next year. But rarely is the best performer in one year also the sector that scores the highest discount to fair value like Financials showed in our value analysis. Usually, the up movement in price brings the value in line - but Financials had a lot of room for recovery given the 2008-09 credit crisis.
The strong 2012 and strong trailing 6 months shows that there are many buyers for Financials in the market right now. This data is encouraging for Financials. Don’t pe picky about your entry on Financials – get in as the getting is good.
Energy shows a mixed bag of data on its price action. It has had a strong 6 month return but has started giving some of that back in the trailing 3-months. Overall in 2012, it is one of the worst performers as it trails every sector except Utilities. We have already said that we don’t even consider Utilities a stock sector – it is more like fixed income.
Energy did not participate in the Bull Market exuberance that kicked off the 2012 year (ie, the January thru April period). Instead, Energy has tended to perform better in the 2nd half while the market has moved sideways. However, the stiff 6%+ pullback in the last 3 months is worrisome. It trails only Technology in its recent pull back.
We still like Energy a lot based on valuation. And the recent price pullback might be a chance to wade in at a better value. Or, the price action could indicate a lack of committed buyers for the sector. You can consider looking for a slight pullback to around $70 for an entry.
Or consider selling cash covered puts to trigger your entry. The $71 January puts are trading at $1.50. If XLE finished below $71 a share at the January expiration, you would get triggered to own it at $71 but you collected $1.50. So, your effective entry would be $69.50.
Now, what about Technology?
We are going to add a special Part 5B to our five part series on Sector Rotation on Wednesday. It will cover the Technology sector and why it is falling out of favor: in both the market place and in our Valuation analysis.

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