This year has been especially confusing in the stock markets. You can see it in relative strength swings among industry sectors. Uncertainty prevails, particularly for sectors that are characteristically high-dividend payers. Consumer sectors are threatened, and the attraction of revived dividend-paying favourites, such as utilities, appears short-lived.
This is happening in both Canada and the U.S., where the national benchmark indices have been divided into 10 sectors. This number is in the process of increasing. The masterminds of the Global Industry Classification System (GICS) have decided to peel real estate away from the financial services sector index and set up real estate as sector index No. 11.
Real estate is not helping stability in the two markets, with uncertain moves so far this year.
Relative strength is the magic ingredient in successful investment strategies. An excellent investment prospect will falter unless your discovery is doing better than the overall market. Rising relative strength would have kept Bombardier Inc. in a portfolio through the 1990s, for example. But since the turn of the century, Bombardier stock’s plunging relative strength would have signalled an investor to avoid the stock.
We use the Standard & Poor’s 500 composite index, the American benchmark, as the baseline for measuring relative strength of Canadian stocks. There are two reasons: first, Wall Street sets the pace and direction for the Canadian market; and, two, the S&P/TSX composite index is unbalanced (too much weight in financials and resources).
Here’s the picture in the Canadian market, as shown by the S&P/TSX capped sector indices. First, sectors that have been rising in relative strength:
– Consumer staples have been beating the overall market since 2008, accelerating since 2014 as demand for dividend-paying stocks intensified. But this momentum has ended, so the continuation of this performance is now in question.
– Information technology – a sector accounting for less than 3% of the Canadian market – has outperformed since 2012. This year, that upward trend is being tested by a drop in relative strength.
– Industrials are bullish, with a series of higher highs and higher lows in relative strength since 2010. Currently, this upward tilt is in force, thanks to improving performance since last year.
– Telecommunications services began rising in relative strength last year, breaking a six-year drop.
Then there are sectors that improved in relative performance this year, breaking long downtrends:
– Materials’ five-year drop in relative strength ended this year, thanks to a revival in gold mining.
– Energy’s relative strength has plunged since 2008. This year’s rally has not changed this long trend, but the sector may be bottoming in relative performance.
– Utilities face the same uncertainty as consumer staples. The sector became wildly popular early in 2015, breaking a four-year drop, as investors rushed to them for dividend yield. This year, the sector has wobbled in relative performance. But they are way below their 2009 peak in relative performance, although the price index did reach a new high earlier this year. That divergence has negative implications.
As for sectors in losing trends:
– Consumer discretionary’s long outperformance of the overall market – which began in 2012 – ended last year, when the sector’s trend of rising relative strength was broken. To confuse the issue, this sector rallied this year.
– Financial services became unattractive in 2009 as their relative performance lagged. This sector has jittered about throughout 2015 and so far in 2016, rising and falling in relative performance in quick succession. This sector is the largest in Canada, currently at 35% of market weight, thanks to the recession in oil and commodities.
– Health care outperformed between 2007 and last year, when the sector started a toboggan slide. This sector is usually a one-stock phenomenon (the latest fallen star being Valeant Pharmaceuticals International Inc.). The sector in Canada is tiny – less than 1% of market capitalization.
And for the big uncertainty:
– Real estate has reached an intersection of rising and dropping relative strength trend lines. The long-term trend is downward. We should learn soon whether real estate’s current superior performance (which started in 2013) can break this downward trend.
On Wall Street, information technology remains in its long-term superior performance. But health care, a market favourite since 2011, broke down this year.
The rise of the two consumer sectors – discretionary and staples – is in doubt. Both have reached converging rising and dropping relative strength trend lines. The sudden upsurge in utilities’ relative strength broke this year.
The energy sector’s rally this year looks more like the start of a basing effort because its relative strength is far below a secular downward trend. This year’s rallies by materials and telecom services look more hopeful for the beginning of new trends.
That leaves three sectors with uncertainty about becoming superior performers. Financials display no real trend in relative strength. Industrials have moved up and down in short bursts since 2011; the sector is outperforming the overall market currently.
U.S. real estate has reached the same crossroads as the Canadian real estate sector: recent rising relative strength has met a dropping trend line.
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