Last week, the stock market posted fairly strong gains, with the S&P 500 up 1.4%. All S&P 500 industry sectors ended the week higher; but the strongest gains came in the utilities (+3.0%), energy (+2.7%), and healthcare sectors (+2.1%). Utility and healthcare stocks are generally viewed as conservative, "risk-off" sectors. Energy stocks have been strong of late because of the rise in oil prices associated with concerns about the developing situation in Iraq. Other sectors normally associated with geopolitical worries also did well last week, including the gold miners, precious metals producers and pipelines, which were the three best performing subsectors in the Dow Jones U.S. Total Market Index.
It seems that the focus of the market has shifted away from concerns about the strength of the U.S. economy and has inched toward the potential impact of a civil war in Iraq (and, to a lesser degree, a civil war in the Ukraine). This may perhaps be reflected in the stock market's performance in early trading today, with stocks down slightly despite stronger-than-expected readings in the ISM's Purchasing Manager's Index and the existing home sales data for May.
Back in April, the U.S. economy took center stage out of fears about potential weakness. Now, it seems that strengthening economic activity is a given. Concerns about Iraq have engendered nervousness in the market, but not enough so far to cause investors to head to the exits.
In recent weeks, a lot of attention has been devoted to the VIX, which remains near record low levels. Many market watchers see it as a sign of complacency. Some wonder whether it is no longer a useful gauge of investor fear. Whatever the reason, it appears that investors have chosen to express their fears about the risk of a sell-off away from the option markets, for example, by buying oil & gas and gold mining stocks. That does not mean that the VIX is necessarily broken, but rather that there are other ways of protecting portfolios and so far at least, investors are not nervous enough to take more significant steps, such as buying puts on the market or selling stocks outright.
That said, it is also clear that the market cannot keep going up indefinitely with defensive sectors in the lead. By some measures the market looks a little stretched. For example, the S&P 500 is currently 3.2% above its 50-day moving average, which is higher than normal. Unless new news rocks the boat, however, I would not expect to see a pullback until we move into the third quarter.
Going forward, in order for the market to maintain its upward momentum, I would expect to see greater participation in the lagging sectors, including consumer discretionary and technology stocks. Along with telecom services, these were among the worst performers last week. Consumer discretionary has been the worst performing sector this year, while technology stocks have recently begun to fade. If geopolitical concerns subside, these sectors should help lead the market higher.
At this time, the Income Builder model portfolio is maintaining its "risk-on" bias, along with its modestly overweight positions in energy and gold stocks and yes, utilities. Like the broader market in recent weeks, I will respond to geopolitical developments going forward by shifting some portfolio positions to reduce or offset risk exposure, as I feel is appropriate.