From the desk of Steve Strazza @Sstrazza
It’s been a close your eyes and buy anything market, particularly the past few weeks as even the most hard-hit areas experienced monster rallies. That appears to be changing this week with the biggest 1-day down move in the S&P since mid-March as well as the largest single-day spike in volatility since February 2018.
Last week we highlighted the healthy rotation into cyclicals. We pointed out that the secular laggards and areas that had suffered serious structural damage were now outperforming, and by quite a wide margin.
We used this scatter plot of our Dow Jones Industry universe to illustrate this price action.
Click chart to enlarge image.
At the same time, we cautioned not to snooze on the leaders. Most of the strongest subsectors in Technology had already reclaimed their highs by this point. A little bit of consolidation after such impressive V-shaped recoveries was only to be expected.
That brings us to this week where the S&P suffered a nearly 6% gap down on Thursday, creating an island reversal beneath year-to-date highs. This was the first time we’ve seen any type of real bearish follow-through since the rally off of March’s lows. Imagine if that wild volatility from Q1 were to return… what kind of stocks are likely to do best in that environment?
Here’s a hint… probably the same resilient areas where we’ve found plenty of profitable long opportunities already this year.
This scatter plot shows the drawdowns in our Industry ETF universe, but compares it to more recent returns. The Y-Axis shows performance since June 5th which is when the majority of stocks peaked.
Notice how all of our favorite Technology subsectors are in the top left of the chart. These secular leaders suffered the smallest drawdowns and strongest rallies this year. Now that sellers are reasserting themselves again, is it any surprise investors are seeking shelter in the areas that continue to serve them best?
Let’s visualize the same data but in table format now. This is the same universe of Industry ETFs, with some extra columns showing new high and momentum data.
What do we see? A lot of Tech and a lot of green at the top of the table. The list is sorted by performance since June 5th. Many of these areas achieved new highs this week while booking very mild losses compared to the -8.5% drawdown for the median ETF.
Look at the bottom of the table now. These are the same areas we’ve been skeptical of as they’ve been secular laggards. Despite their recent reprieve in performance relative to the rest of the market, they’re right back where they started after Q1’s crash… at the bottom of the barrel. All it took was a few days of weakness for these usual suspects to show their true colors again.
As shown in the table, groups like Airlines, Energy, and Banks have suffered far worse losses than their peers since internals peaked.
Whether the market continues higher from here or not we’ll continue to look to the leaders for the best opportunities. But even in a down market, it’s not smart to bet against these areas.
Thanks for reading and please let us know if you have any questions!