Since the market’s March 9 low, stocks and exchange traded fund (ETFs) have more or less stabilized and the fear has abated. But some have noticed interesting things about this recovery: it’s not proceeding exactly according to plan.
Corporate earnings are on the up, with upgrades exceeding the amount of downgrades in many markets for the first time in recent memory. Now, the market has been more focused on improving trends. Sectors that suffered from the sharpest falls stand to benefit the most from the economic recovery. Sectors like industrial cyclicals, financials, small-caps and commodities have all been performing above the market norms, remarks Stephanie Butcher for FT Adviser.
However, cyclical sectors don’t always lead the market. For instance, in between 1994 and 1999, cyclicals underperformed a rising market, with defensive sectors such as consumer staples, health care and utilities leading the way. Like that period, most cyclicals look fully valued and “defensives” look cheap on an absolute basis. [Why you shouldn’t listen to ETF Nostradamuses.]
The current situation has given rise to a market oddity in that some companies trade on significant price/earnings ratio discounts to that of the market and historic premiums compared to dividend yields. The market is also discounting a recovery in cyclically sensitive earnings – around 40% earnings growth is needed to bring cyclical price/earnings back to normal levels.
The subdued expansion looks like a “V-shaped” recovery, and if this holds true, the more economically-sensitive sectors, which are priced for the “V,” may prove to dismay investors.
Market “historicals” are interesting to take note of and can help you locate areas that could present opportunities at some point, but investors can put a trend following strategy to use to identify the actual opportunities that take place. As this recovery has shown, it may not always be what the markets historically expect. [10 tips for managing risk.]
For more information on trend following, visit our trend following category. More on trend following can be found in The ETF Trend Following Playbook.
Max Chen contributed to this article.