Sector rotation—mass movement of investors into and out of stocks from certain industries—has been one of the major market themes of the past two years. While the broad market has moved mostly sideways since June 2014, specific sectors have experienced long periods of divergence and outperformance or underperformance. Below, we take a look at some of the major rotations of the past year, and how, when—or if—they were resolved.
Our interest in these rotations isn’t purely academic. We’re adding a dividend-paying biotech stock to our Cabot Dividend Investor portfolio today in anticipation of an end to the rotation out of biotech stocks. On the other hand, we sold the remainder of our position in a retail stock on Monday in part because we believe retail stocks are likely to remain out of favor for some time.
Energy & Commodity Stocks
The collapse in commodities is the granddaddy of the recent rotations, with the sector’s biggest losses coming as oil prices crashed in the second half of 2014. Slowing growth in China, the dollar’s relentless rise and historic droughts (and floods) were among the many culprits for the collapse.
Many continued falling throughout 2015, and defaults began to pepper the energy industry in particular. But the prices of most commodities have finally begun to rebound in 2016. Iron ore and gold prices both put in solid-looking bottoms in December 2015, and many more commodities indexes have been rising since January. Oil prices finally put in a convincing bottom in February. However, silver, corn and natural gas prices are among the commodities that have yet to recover.
From its peak in July 2015, IBB fell 40%, before bottoming along with the broad market this February. Since then, biotech stocks have been fairly stable, and it looks like the rotation may have ended at the seven-month mark.
Biotech Stocks
In the five years from July 2010 to July 2015, the iShares Biotech Index (IBB), which tracks the price of biotech stocks, rose 392%, more than three times as much as the S&P. Then last summer, political condemnation of high-priced drugs and other factors combined to trigger a significant, sustained selloff in the sector.
From its peak in July 2015, IBB fell 40%, before bottoming along with the broad market this February. Since then, biotech stocks have been fairly stable, and it looks like the rotation may have ended at the seven-month mark.
Financial Stocks
Financial institutions like insurers and banks benefit from higher interest rates because they can earn more by investing their float (the money they’re holding on to for people). So the Fed’s December 2015 interest rate hike was good news, and investors anticipated steadily rising rates would soon follow.
But less than a month later, as you can see in the one-year chart of the financial SPDR below, those dreams died, as it became clear that following rate hikes were likely to come slower, and possibly be smaller, than anticipated. Investors in financial industry stocks panicked a little, and the sector was among the worst performing during the New Year’s market crash.
The rotation out of financials was short-lived, ending after just two months. Financials outperformed the broad market in March and April, and are on track to do slightly better than the S&P this month as well, thanks to the significant uptick in expectations of a July rate hike last week.
Yield Sectors
On the flipside are “yield sectors” that typically suffer from rate hikes. In April of this year, we saw a major rotation out of conservative, high-yielding equities including telecoms, utilities, tobacco stocks and many consumer staples stocks.
As interest rate expectations rose this spring, bond yields began to rise accordingly. When bond yields rise, high yielding, conservative equities that are considered bond alternatives become less attractive. In addition, the market’s strong rebound from February’s lows increased investors’ appetite for risk, and many dumped their most conservative holdings in favor of more aggressive positions.
Valuation may have also played a role in this rotation. Consumer staples, utilities and tobacco stocks were some of the best performers during the market’s New Year’s correction, rising to rich relative valuations. As the market stabilized, value-oriented investors began looking to year-to-date underperformers for bargains—stocks in sectors like financials, energy and commodities.
The utilities and consumer staples indexes gained some ground as the broad market faltered in early May, but have since resumed their underperformance. It remains to be seen if this rotation will persist or turn out to be a mere blip in early 2016.
Retail Stocks
The latest rotation to rock the market, the exodus from the retail sector in the last two months was triggered by lousy earnings from brick-and-mortar department stores and apparel retailers. Still young, we’re watching closely to see if this trend persists or reverses.
From Cabot Dividend Investor May 25, 2016.
