In Q1, the Energy sector was what separated the winners from the wannabes for the most part. Energy returned 16%, twice as much as the next best sector and 3X the overall market. Small-Cap Energy performed even better, posting an almost 25% return.
5 weeks later, the picture is dramatically different, perhaps best captured by looking at the relative performances of yesterday's sector star and the new sector leader, Healthcare (click to enlarge):
Energy has collapsed, giving up 6% so far this quarter, while Healthcare is up 7%. Year-to-date, now, Healthcare has surpassed Energy, which is in second place at a not-too-shabby 9.9% compared to Health at about 12.6%. It's worse for Small-Cap Energy, which is down 12% QTD. In early April, I had first warned of my concerns about Energy, suggesting conservative investors move to Large-Cap Technology, which is up about 2% QTD. More recently, I shared my expectation for a 10% correction in Energy.
I think we will hit the objective I shared in coming days.
I think that this action is extremely positive for the market, but I recognize that the short-term implications can be negative. Last October, I shared my forecast for 2011, suggesting 1500 on the S&P 500 was in the cards. We are essentially on track, with the S&P 500 up about 7%, 1/3 of the way through the year. Rising energy prices and other commodity prices stand out to me as a real impediment to my forecast being achieved, as they could destroy demand or lead the Fed to be more aggressive with interest-rate policy than would be otherwise warranted.
So, with all this "good news', why did stocks get trashed last week? Unfortunately, when people are losing money in one part of the market, they tend to reduce exposure in other names. This is a very short-term phenomenon. If we look at what happened just this week, most of the damage was in Energy and Materials. In fact, Health, Telecom Services and Utilities were up, while Consumer Staples and Consumer Discretionary declined less than 1%. Tech, Industrials and Financials all fell less than the S&P 500. Classic rotation. The beneficiaries were non-cyclical sectors, but even those with some cyclical exposure fared relatively well. So, I see the Energy correction as an intermediate-term positive.
I recently launched an ETF Model, Sector Selector ETF, where I am attempting to position the portfolio towards sectors of the market that I believe offer above-market potential and to minimize exposure to those parts of the market that I expect to underperform. It's really an extension in some ways of what I have been doing with my other two models, which use individual securities. While I don't target Top 20 or Conservative Growth/Balanced in a top-down fashion, as I am here, I certainly make large sector bets in both models. The bets I am making here are pretty similar. When we launched a week ago, I positioned the portfolio with 8 ETFs (in descending exposure):
- Rydex Russell Top 50 (NYSEARCA:XLG)
- SPDR Technology (NYSEARCA:XLK)
- Vanguard Emerging Markets (NYSEARCA:VWO)
- SPDR Financial (NYSEARCA:XLF)
- SPDR Health (NYSEARCA:XLV)
- SPDR Consumer Discretionary (NYSEARCA:XLY)
- SPDR Utility (NYSEARCA:XLU)
- PowerShares Small-Cap Industrials (NASDAQ:PSCI)
You can sign up for a free trial if you would like to see the actual weights, which we adjusted late this week (slightly more VWO and PSCI, less XLV and XLU). The big bets are clearly a major focus on the largest names, which I think are somewhat undervalued relative to the market, and the exposure to emerging markets. EM is a little behind so far in 2011, and my expectation is that it can do about 10% better for the full year than the 20% or so I forecast for the S&P 500. The momentum has improved recently.
Technology is the largest sector, and, combined with XLK, we have a decent overweight there. I am lumping Tech and Industrials together and view the PSCI and XLK as taking care of that overall exposure. Large-Cap Industrials seem expensive to both Large-Cap Tech and Small-Cap Industrials. YTD, Large-Cap Industrials have returned about 9%, while Small-Cap Industrials are up about 3.5%. I like the M&A dynamic here too.
I view our Health and Consumer Discretionary exposure as fairly neutral now, with the Utilities covering for Telecom Services too. Purposefully, we continue to have no Energy or Materials exposure for now (except for what's in XLG). As I have written before, I find Large-Cap Energy to be quite attractive, so I actually like what's in XLG with respect to Energy for the most part.
Finally, Financials have been a big laggard for years, and I sense that they could assert some leadership this year as the return of the dividends kicks in. I view us as pretty overweight the sector.
As the correction in Energy ends, I anticipate adding exposure in the ETF model as well as my other two. Technology plays, shale gas E&P players and large integrated companies will likely perform well over the balance of the year, while I expect pressure on oil to keep a lid on oil-focused E&P companies.
Disclosure: As disclosed above, the Sector Selector ETF Model holds positions in several ETFs mentioned