The Lifeblood of Bull Markets: Sector Rotation

We spent a lot of time this year talking about "the safety trade." We used this term to describe the outperformance we were seeing from some of the defensive sectors of the market, namely Utilities, REITs, and Consumer Staples. These three sectors are now falling out of favor as investors rotate into more cyclical, "risk-on" sectors of the market.

Here's a chart showing how Staples, Utilities, and Real Estate, as a group, have performed relative to the S&P 500 ($XLP+$XLU+XLRE)/$SPY. The indicator at the bottom of the chart shows the 10-day rate of change for this ratio. The group is currently down over 6% in the past 10-days relative to $SPY. Today marks the worst 10-day rate of change for the group since January 2018.

Between Spring and Fall of this year, these three sectors were breaking out to all-time highs and outperforming the broader market. Some argued that low bond yields were causing these high dividend-yielding sectors to catch a bid as they offered yield-seeking investors a place to hideout.

The chart below shows the YTD performance of Staples, Utilities, REITs and the S&P 500 up until October 1st. You can see that all three sectors we're outperforming the S&P 500 until October.

Now let's see how they've fared since October 1st...

Relative Rotation Graphs or RRGs offer an even better visual of this rotation. Below is a daily RRG showing the 11 sectors of the S&P 500 from October 1st until now. Notice how $XLP, XLU, and $XLRE  all went from the leading quadrant (upper right) to the weakening quadrant (lower right.) At the same time, sectors like Energy, Industrials, and Financials are beginning to perk up. Read this for more on how to interpret Relative Rotation Graphs.

So is this rotation bullish for the broader market? Yes.

We don't want to see the defensive sectors crash and burn. However, it would be bullish to see some of the more cyclical sectors take charge.

Legendary Technician, Ralph Acampora always says  "rotation is the lifeblood of bull markets." In other words, you want to see sectors passing the baton back and forth in a secular bull market. In the tweet below, Ralph weighs in on the shift from defense to offense.

We'll continue to keep an eye on this and report back with any major developments. As always, feel free to contact us with any questions.