It wasn’t that long ago when I¬†criticized terms such as “overbought” and “undervalued.” (See April’s Going Global: Rethinking the Overbought Concept.) In essence, I explained why investors may¬†give more credence to¬†powerful-sounding words than they give to¬†common sense information.
With that said, you should look at a sector’s P/E ratio and compare it against the sector’s P/E across time. If SPDR Select Utilities (XLU) typically trades at a P/E multiple of 12, but currently trades at a multiple of 20, you¬†need to¬†evaluate the reason for the premium that’s being paid.
Similarly,¬†you should consider the current price of a Sector ETF in relation to its 50-day moving average. Is it unusual for the ETF to be 7.1% above a short-term¬†trendline? Are most sectors above their respective moving averages by more than 5 percentage points? Does the uptrend signify normal sector rotation or an increase/decrease in risk tolerance?
|Sector ETFs: Percentage Above 50-Day Moving Average||¬†|
|Health Care Select Sector SPDR (XLV)||¬†||¬†||7.1%|
|Consumer Staples Select SPDR (XLP)||¬†||¬†||5.5%|
|iShares Dow Jones Telecom (IYZ)||¬†||¬†||5.3%|
|Utilities Select Sector SPDR (XLU)||¬†||¬†||4.8%|
|Industrials Select Sector SPDR (XLI)||¬†||¬†||3.8%|
|Consumer Discretion Select SPDR (XLY)||¬†||¬†||3.7%|
|Technology Select Sector SPDR (XLK)||¬†||¬†||2.7%|
|Materials Select Sector SPDR (XLB)||¬†||¬†||2.5%|
|Financials Select Sector SPDR (XLF)||¬†||¬†||0.0%|
|Energy Select Sector SPDR (XLE)||¬†||¬†||-0.3%|
A simplistic assessment of the data might note that 9 of 10 sectors are above 50-day MAs and that all sectors are above longer-term trendlines. Armed with this knowledge alone, you might simply decide to be “fully invested.”
On the other hand, one might view the data as a sign that Staples (XLP) and Healthcare (XLV) are “overbought.” Indeed,¬†if you measured the distance above¬†the 50-day in standard deviations rather than actual percentages… non-cyclicals would be severely overbought.¬†You might even be inclined to buy economically sensitive segments like Materials (XLB) and Energy (XLE) in order to rotate out of “overbought” sectors.
In my estimation, however, the data warrant greater scrutiny.¬†For instance, how did the same table look before the rebellion in Libya?¬†Saving you some trouble… cyclicals like Energy (XLE) and Industrials (XLI) were the¬†clear momentum¬†leaders. Financials (XLF) and Technology (XLK) weren’t that far behind.
Meanwhile,¬†the mainstream financial media have peddled the notion that¬†earnings season pushed equities to multi-year highs. The reality? Mutual fund managers and insititution¬†advisers needed to put record equity inflow to work in April; reluctantly, many¬†acquired defensive positions like¬†commodity-burdened Staples (XLP) and¬†no-growth Utilities (XLU).
If earnings reports/guidance meant as much as others would have you think, you’d have seen a huge boost to¬†tech and energy investing. Alas, we’re not seeing that. In fact,¬†advancing¬†stock volume for non-cyclicals has been far greater than declining¬†stock volume. Yet advancing¬†stock volume for cyclicals has been far less than¬†declining stock volume.
When you couple weak volume breadth for economically sensitive sectors (i.e., “cyclicals”)¬†with smaller percentages above 50-day MAs,¬†one gets the sense that there’s trepidation about the U.S. economy’s ability to support itself. Common sense suggests that nothing lasts forever… not even a weak-dollar,¬†Fed-fueled, risk rally.
Cyclicals can easily get back on track. However, investors will demand more evidence of a self-sustaining U.S. economy.¬†Until that evidence comes in, there’s only so much that a rapidly declining dollar can do.
Disclosure Statement: ETF Expert¬†is a web log (‚ÄĚblog‚ÄĚ) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships. You may review additional ETF Expert disclosure details here.