Economic cycle: is a sector change underway?


The strength of commodities this year is not surprising, as they do best at the end of the economic cycle, when inflation is running high and inflationary squabbles have yet to dampen demand. Add to that the global supply disruption due to the war in Ukraine, and the recipe for gains was perfect.

Unfortunately, the safe haven status of commodities could fade.

Over 20 years ago, I was a partner in a sales firm that did a lot of research on industry pricing trends. It stuck with me. I continue to track the price performance of exchange-traded funds across major sectors to help me focus on the best baskets for new ideas. Lately, this research has moved me away from late-stage groups like energy toward recession-stage sectors.

Specifically, while the Invesco Commodities ETF (CBD) is up 7.7% in the second quarter, its performance has lagged the market since the S&P 500 bottomed on May 20 and June 17. The situation is similar for the ETF Energy Select SPDR (XLE) . Its swoon last week made its quarterly performance negative. It is still up 14% higher than the S&P 500 this quarter, but has lagged the S&P 500 since May 20 and June 17. The Oil & Gas Equipment SPDR (XES) did worse. Following its recent selloff, it is now lagging the S&P 500 this quarter, and since May 20 and June 17 (see chart below).

The recent underperformance suggests investors are moving away from late-stage inflation plays like energy toward defensive groups that do better during a recession.

Is it time to overweight health care?

Early-cycle baskets like technology and financials fare badly as inflation pinches corporate margins and consumer wallets shrink. However, healthcare stocks tend to lead late in the cycle, as worries about the Fed-induced recession rise along with inflation; the group is also leading a recession because investors are flocking to stocks inelastic to economic activity, such as drugmakers.

The recent momentum in health care suggests that investors are pouring more dollars into it.

The Healthcare Select SPDR ETF (XLV) fell only 9% in the second quarter, about 8% better than the S&P 500. It has lagged the S&P 500 slightly since its May low, but its 4.1% gain since June 17 is 1.8% higher than the S&P 500 and 2% higher than the Technology Select SPDR ETF.

Biotech is doing even better.

Note: I follow two biotech ETFs, the iShares Biotech ETF (BWI,) and SPDR Select Biotech (XBI,) because their holdings and portfolio weightings differ (the BWI is more heavily weighted towards large-cap biotechnology).

The BWI has outperformed the S&P 500 since the start of the quarter, since May 20 and since June 17. The XBI has lagged since the start of the quarter, but like the BWI, it has also been leading since the May and June lows. Its performance has been exceptional over the past week, gaining 6.2% since June 17, almost 4% better than the S&P 500. The BWI is up 3.4% from the low of the last week, which is also well ahead of the market.

ETFs highlighted in green outperform the S&P 500.

Indeed, health care appears to be benefiting from recent weakness in commodity inventories and the growing risk of a recession caused by interest rates rising faster than expected.

It’s not just health care

Healthcare isn’t the only recessionary basket gaining traction lately. The Select Utilities SPDR ETF (XLU) fell from the May low, but is still well ahead of the market since the start of the quarter, and is up almost 4% since June 17. Select Consumer Staples SPDR ETF (XLP) which was hampered by exposure to Walmart (WMT) and target (TGT) has outperformed the S&P 500 since the start of the quarter and since May 20.

We are also starting to see signs of life in telecoms, a basket that only leads to the downturn phase of the cycle.

In June, the iShares US Telecom ETF (IYZ) hit a low one day before the market – the 16th. Since then it has risen by 4.75%. For comparison, the S&P 500 is up 2.8% from its June 16 intraday low.

Admittedly, a week isn’t much of a trend, but investors seem to be closing in on recession-resistant stocks.

It is certainly true of MORE Action Alerts. In “Leave 2 positions, roll 1 and add to 3“, co-portfolio managers Bob Lang and Chris Versace announced that they had sold shares and taken a new stake in telecommunications giant, Verizon (VZ) this week.

Lang and Versace write:

“We are funneling proceeds into a new position in Verizon Communications stock with a target of $60. Adding the stock’s current dividend yield of 5.1%, we start with a rating of “1” for this defensive business model and dividend-paying company.

As we will explain in a much more detailed overview of the company which will be released for members shortly after this trade alert, we see a slight decline in stocks from both a fundamental and technical perspective, while expectations EPS for the upcoming quarters have yet to be waived for previously announced wireless price increases, some of which are beginning to be implemented today.

As we tend to do, we are starting with a starting position in VZ shares, and will look to expand this position size at better prices if they arise.

The smart game

In “Is it Game-Over for Energy Stocks” on June 14, I concluded “If the XLE closes below its 50-day moving average, make sure you are using trailing stop losses to protect your portfolio. don’t want to turn a winner into a loser. Remember that energy actions are called “cyclical” for a reason. At some point the music will stop and you don’t want to be without a chair when it happens. »

Indeed, the XLE broke through 50-DMA and now it’s hard to support 200-DMA. Meanwhile, the S&P Oil & Gas Equipment ETF failed the 200-DMA, suggesting it’s wise to sell rallies in the basket. Sure, the XLE might stand out near its 200-DMA, which can get you some top-notch action here to bounce back, but even more so than the 14, it’s rentals and you have to use trailing stops to protect you. .

The broader commodities market could be more risky. DBC broke below its 50-DMA yesterday, and unlike energy, which is only about 5% above its 200-DMA, DBC is likely to drop 13% before it finds its footing. at 200-DMA.

Again, if you are long in commodities, protect yourself by reducing exposure and using stop losses so you don’t get caught out.

As for new funds, it’s time to increase exposure to recessionary groups, particularly healthcare. The market does not move from stage to stage in a flash, so there should be down days to buy. And, unlike other sectors, many stocks, especially drugmakers, biotechs and health insurers, are trading above the 200-DMA with growth in revenue and earnings.

If picking individual stocks in defensive sectors isn’t your thing, you can always use the ETFs I mentioned for quick exposure to a large number of stocks from these groups.


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