Research Excerpts

New Sector-Related Indicators For 2014

Posted on: Wednesday, January 22nd, 2014

Sector Watch, one of 8 different reports that we produce for Asbury Research subscribers, is a monthly report that reviews and updates our current picks for relative outperformance or underperformance in the various sectors of the S&P 500, and also discusses emerging sector-related opportunities for the upcoming 1-2 quarters according to a number of metrics including market momentum, investor asset flows, and price structure in related assets. Our sector rotation analysis is an integral part of our macro forecasting process for US financial asset prices and the broader US economy.

We recently added some new, proprietary metrics to our sector analysis to better determine not only when new trends of relative outperformance or underperformance are likely to emerge, but more importantly when sector-related asset flows support and and can potentially fuel these emerging new trends.

The following (green highlights) is an excerpt and several charts from our January 10th Sector Watch report (access requires subscription), which introduces and explains these new metrics.


New Sector-Related Indicator Additions For 2014

For years we have measured investor asset flows between the various sectors of the S&P 500 via our own metric, a pie chart that displayed the percentage of sector bet-related assets as represented by the Rydex Sector Funds, that were invested in each sector of the S&P 500 as represented by the iShares Select Sector SPDR ETFs.  We initially used the Rydex funds because, at the time, they were the only sector-related funds that published their asset flow data daily, and had enough data history to make our metric meaningful.

However, effective immediately, we will be using a new, and we think much better, sector asset flow metric that replaces the Rydex asset flow data with the actual data from the Sector SPDRs, the latter which have now accumulated enough history to be a more meaningful, apples-to-apples study of current asset flows in sector ETFs. We have also added some additional sector-related asset flow metrics that allow us to more accurately and precisely follow the money in US market sectors.  These new charts will always appear in Sector Watch, and will also be included in our other reports as appropriate including Keys To This Week

Here they are, with a brief explanation of each.

New Composite Sector Asset Flow Comparison Charts

Chart 1 shows the historic daily average distribution of investor assets in the 9 Sector SPDR ETFs since our data series began in June 2006.

Chart 1
Chart 1

Chart 2 displays the distribution of these sector bet-related assets on January 7th. The red highlights show that the two most over-invested sectors are currently Consumer Discretionary (9% of the sector pie vs. 5% historically) and Industrials (12% versus 7% historically). The green highlights show that the two most under-invested sectors are Utilities (6% vs. 11% historically) and Energy (11% vs. 18% historically).

Chart 2

Chart 2

This metric is not a near term timing tool that tells us what to do today, but rather a more intermediate term metric that identifies the sectors that are currently “offsides” according to historic investor asset flows, and have thus have the most potential for an upcoming move back to historic norms over the next 1-2 quarters.

Daily “Percentage Invested” Charts For Each Sector

These charts are brand new for us and, to our knowledge, no one else is doing anything like this.  The blue line in the upper panel of Chart 3 (next page) plots the daily relative performance of the Financial Sector SPDR ETF (XLF) versus the SPDR S&P 500 ETF “Spyder” (SPY) since 2012.  The black line in the lower panel plots the corresponding daily percentage of the sector pie (as shown in Charts 1 and 2) that the Financial Sector comprises, along with its quarterly moving average (63-day, red line).

Chart 3

Chart 3

There are 3 important questions to ask yourself when interpreting this metric:

  1. Is it at an historically high or low extreme?
  2. How has the relative performance line reacted when it’s been there before?
  3. Is the percentage of the “pie” that the sector comprises growing or shrinking?

The green highlights show that periods when the daily percentage of the “pie” that Financials comprises is expanding, above its quarterly moving average, the sector typically outperforms the S&P 500 (the blue line in the upper panel rises).  Conversely, the red highlights show that when the daily percentage of the “pie” is shrinking, the sector typically underperforms (the blue line in the upper panel declines).

The green ellipse at the lower right edge of the chart shows that the percentage of the sector pie has most recently expanded back above its quarterly moving average indicating that the amount of sector bet-related assets being allocated to Financials is increasingAs long as this continues, recent relative sector outperformance is likely to continue as well.

Daily Asset Flow Charts

The blue line in the lower panel of Chart 4 below plots the total daily assets invested in the Industrials Sector SPDR ETF (XLI) since 2013, with the 21-day (one business month) moving average of these assets plotted in red.

Chart 4

Chart 4

The red highlights show that when these assets are contracting, below their monthly moving average, XLI declines.  However, as long as the daily assets remain above their moving average, this new money —  think of it as “trend fuel” —  coming into the fund keeps the positive price trend intact.

Summary

These changes and additions provide an accurate, detailed, and insightful under-the-hood look at what is going on in the various sectors of the S&P 500, to:

  1. indicate which sectors are historically over or under invested
  2. define how the sector has previously reacted to similar extremes in investor participation
  3. determine when investor participation in a given sector is increasing or decreasing
  4. show when daily asset flows support a trend reversal.