Flight to safety or sector rotation?

Cyclical and defensive sectors nicely diverged in yesterday’s trading.

Source: Industry Performance Chart 2018/09/06

The same pattern can be seen when looking at the performance since August 29th:

Source: Industry Performance Chart 08/29-09/06

So far this looks like to me as a healthy correction in an uptrend. Stretched/leading sectors were sold more heavily, while money went into the laggards.


Disclosure: We have no positions in XLRE,XLY,XLK,XLI,XLB,XLE,XLP,XLV,XLU,XLF.

Positive EPS Guidance To Drive Markets?

A potential positive catalyst for the year ahead:

From December 31 through February 15, 127 S&P 500 companies have issued positive EPS guidance for 2018. This number is more than double the 10-year average of 49 for this same period. In fact, this number marked the highest number of S&P 500 companies issuing positive EPS guidance for a year (through this point in time) since FactSet began tracking guidance data in 2007.
The sector breakdown of EPS guidance is very pro-cyclical:
What are the drivers of this optimism:
What is driving the increase in the positive EPS guidance for 2018? The decrease in the corporate tax rate for 2018 due to the new tax law is clearly a significant factor. Other factors contributing to the increase in positive EPS guidance likely include an improving global economy and a weaker U.S. dollar.
A similar picture emerges as one looks at the performance of each sector year-to-date:
Could it be the major force behind the performance of the S&P 500 this year?
Disclosure: We don’t have any positions in the above ETFs.

February Performance Review

So how this market rout in February affected the different sectors in Europe and the US?

Let’s look at the peak-to-trough period of 10 days from 01/26/18 to 02/08/18, when the SPX Index fell more than 10% (with the intraday decline next day, the fall was 11.84%):

Source: Bloomberg

This is how the various sectors performed in the S&P 500 Index:

Source: Stockcharts.com

Broadly speaking, the sectors that fell less than the market were defensive sectors like Utilities and Real Estate or Staples, while the underperformers were Energy and Healthcare.

In Europe, the decline was only around 8.50% on a close/close basis, but it started a bit earlier and ended 1 day later, so we’re looking at the period between 01/23/18 to 02/09/18.

Source: Bloomberg

The performance of different sectors are a bit different across the ocean:

Source: Bloomberg

Classic defensive sectors such as Telecom and Utilities were underperformers, while Real Estate fell slightly lower than the market. The common theme is the higher beta of the Energy and Healthcare sectors on the downside.

It is hard to say what might have caused this pullback, but it is telling that the Energy sector was leading to the downside, while the price of oil fell about the same amount as the stock indices. This coincided with a rise in long-term interest rates (which by the way were rising for months now), and heavy positioning.

It will be interesting to watch who will come out ahead of this slump, and which sectors will be the laggards.


Not A Great Start Of The Year…

at least for the Real Estate sector…

The below chart shows the equal weight sector ETF performance YTD, representing what the average stock gained/lost in 2018 so far. Real Estate stocks lost 3% on average, being the second worst performers.

Source: Stockcharts.com

The same can be said about the market cap weighted sector ETFs, Cyclical sectors are outperforming while the Defensives are lagging the market:

Source: Stockcharts.com

Disclosure: We have no positions in the above ETFs.

Performance Difference Drivers For Same-Sector ETFs

This article on etf.com provides a good summary of the question I’ve been looking at lately:

“The Vanguard REIT ETF (VNQ) has $34 billion in assets, significantly more than the $2.5 billion in the Real Estate Select Sector SPDR Fund (XLRE), which tracks the aforementioned S&P 500 sector index and the approximately $400 million Fidelity MSCI Real Estate Index ETF (FREL); however, VNQ’s 3.6% total return was below the gains for XLRE (8.6%) and FREL (6.8%).” Source: Vanguard REIT ETF Getting Makeover

How can these newcomers outperform the old beast? Probably because they track different indices, but they all supposed to track the Real Estate sector, right?

To understand the performance difference on must look under the hood, a.k.a. look at the holdings of each ETF. It is normally enough to check the top 10 or 20 stocks by weight to find the answer.

Source: Bloomberg

What’s striking is that VNQ has zero weight for American Tower (AMT) and Crown Castle International (CCI), two cell tower REITs. What’s more, the fund XLRE seems to be more concentrated in these names than the rest.

So our hypothesis now is that probably these two stocks have done better than the rest to cause XLRE and the two other to outperform VNQ this year. Let’s see if it is true!

These are the daily charts of the two stocks, with the lower panel depicting the relative performance of each stock to the VNQ etf:

Source: Bloomberg

Source: Bloomberg

The two have been massively outperforming the rest of the sector (represented here by the VNQ etf) since January, as can be seen by the rising red line in the lower panel. The price broke out of a post-election retracement consolidation range at the same time as the relative performance line broke above the descending trendline.

In light of this, we can easily explain why XLRE (and the two other ETFs) has been trailing VNQ since the beginning of September! Each of them has retraced some of its gains after breaking out to all time highs in August.

Source: Bloomberg

So in terms of fund selection, it comes down to whether these two will continue outperforming their peers or not. At least until the benchmark change in 2018….

Disclosure: We are long VNQ.


June Sector Flows and Survey Sentiment

State Street is out with its chart pack for June. Regarding the Real Estate sector, sector flows into ETFs were mediocre in June, while YTD the inflows are significant compared to other sectors:

Source: State Street Global Advisors

Based on their survey, investors are quite bearish on the sector, as Real Esate is the second most underweight sector and the lease loved after Utilities:

Source: State Street Global Advisors