Today we return to our “12 Days” series to discuss supply and demand as well as sector leadership.
We all intuitively understand why prices for fresh fruits are higher in the winter – less fruit is being produced so there is a lower supply; why is candy cheaper on November 1? – demand drops off after Halloween. Just like the supermarket, supply and demand affect prices in financial markets. The law of supply and demand favors certain asset classes, sectors, and stocks at different times. Energy stocks may be in demand if investors believe that oil prices will increase. Technology stocks could be favored when people believe compelling innovation is forthcoming.
The broad US equity sector performance quilt is an effective way to illustrate how sector leadership can change dramatically from year to year and the effect that selecting the strongest sectors (and avoiding the weakest) can have on overall return. If you owned the broad S&P 500 Index in 2011, you would have had a 2.11% return, however, an equally-weighted portfolio of the top three sectors, Utilities, Consumer Staples, and Healthcare, would have earned a healthy 11.92% return. Healthcare is an excellent example of how dramatically sector leadership can change. Between 2004 and 2016 Healthcare was among the top three best performing sectors in seven out of thirteen years – more than any other sector; however, it was also the worst performing sector in four years – once again, more than any other sector.
Source: Bloomberg
In order to identify the sectors to overweight, and even perhaps underweight, we use a tool called Dynamic Asset Level Investing (DALI). DALI uses relative strength to provide a streamlined, dynamic snapshot of the financial landscape to aid us in properly allocating client portfolios across all types of assets in various market environments. DALI monitors the market on a daily basis, comparing every member of the DALI universe to each other on a relative strength basis. These comparisons provide an active ranking of the broad asset classes and their respective sub-classes.
Currently, and as it was throughout 2017, Domestic Equities is the highest ranked asset class within DALI, followed by International Equities. Within Domestic Equities, Technology, Financials and Industrials currently hold the one, two, and three spots, respectively, and those positions were fairly consistent for the majority of 2017. The sell off in Technology a couple weeks ago appears to have been a brief disruption to the sector’s 2017 ascent, as it remains the clear leader in DALI and has shown few, if any, signs of weakness.
Until next time, cheers!
Jim