Aftermath of the Stock Market Correction: Retailing, Defense and Banking Sectors are the New Leaders; Communications Equipment Fund is the First Sector Fund to Break Out to a New High

After the unexpected correction last week, the U.S. equity market rallied back in the last three days, in spite of fears of rising interest rates and inflation:

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Based on the three-month total return, which is a measure of price momentum, the consumer cyclicals (such as retail), industrials (such as defense) and the financials (such as banking) sectors led the market higher:

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We continue to like the technology sector, as well. In fact, the only sector fund that made a new all-time high today is the Fidelity Select Communications Equipment Fund (FSDCX), which represents a sub-sector of the broader technology sector:

fsdcx.021418.png

 

View fund rankings at FidelitySectorReport.com for more information.

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Stock Market Sell-off is Caused by Rising Interest Rates; Cyclicals, Financials and Industrials Remain the Strongest Sectors; Treasury Bond Funds Underperform

In January the stock market became dangerously overbought following the tax reform rally, and as we anticipated, a sell-off occurred:

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Chart 1.

The sell-off was triggered by rising interest rates, fears of rising inflation, and the potential of a more aggressive monetary policy by the Federal Reserve.

A worrisome sign for the stock market is that shorter-term interest rates are rising faster than long-term rates, which could lead to yield curve inversion, a condition where short-term rates are higher than long-term interest rates. The bottom panel of Chart 2. shows the ratio of the 10-year vs. 30-year yield indexes. The ratio line is steadily rising since last July, as denoted by the blue arrow:

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Chart 2.

Rising interest rates negatively impacted funds that invest in this space:

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Chart 3.

The stock market sell-off is uneven with some sectors falling faster than others. Currently, the spread of the total return between the best and the worst sectors over the last three months is 25%. Should the market continue to drop, we think that this spread will continue to widen. Conversely, if we see a relief rally by mid next week, the spread will probably become more narrow.

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Chart 4.

The industry groups with the strongest relative strength vs. the S&P 500 index are the cyclicals (consumer discretionary), financials and industrials. We’d like to highlight financial services and defense stocks (part of the industrials group) as two sectors that can potentially lead the market once the market correction ends.

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Chart 5.

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Chart 6.

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Chart 7.

We continue to like the technology sector, as well, because of its lesser dependence on changes in interest rates and because of the proliferation of disruptive technologies from robotics to intelligent software:

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Chart 8.

 

View fund ratings at FidelitySectorReport.com for more information.

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Large Price Drop of the Fidelity Select Industrial Equipment Fund is Due to Capital Gains Distribution

The Fidelity Select Industrial Equipment Fund experienced a large drop of its net asset value (NAV) on Tuesday. The explanation is that yesterday was the ex-dividend date for this fund and the $5.542 per share dividend was paid out:

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More information is available at the Fidelity.com website (https://fundresearch.fidelity.com/mutual-funds/fees-and-prices/316390533):

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View fund ratings at FidelitySectorReport.com.

 

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Why Diversify your Portfolio in 2018?

While technology, industrials, and cyclicals were the strongest sectors in 2017, we think that it may make sense to diversify into additional areas, such as the health care sector, to protect against the potential of increased volatility in 2018.

Currently, the Fidelity Select Medical Delivery Fund (FSHCX) is the strongest fund in this sector based on its three-month total return. FSHCX holds investments in health care insurance and service companies.

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In our view, another excellent investment fund is the Fidelity Select Medical Technology and Devices Portfolio (FSMEX), which primarily invests in companies that manufacture medical equipment and surgical devices. The chart shows that the price consolidated in the last 6 months, however, the current rally can lead to a new breakout, which will likely lead to increased rotation into this sector:
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View model portfolios at FidelitySignal.com for more information.

 

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Top Sectors are Overbought, a Sell-Off is Likely

2018 started on a good note for equity investors. After the first few days of trading, the Nasdaq index moved above the 7,000 level, while the Dow Jones Industrial Average surpassed the psychologically important 25,000 level.

The market rally is broad-based, which allows investors to diversify across of multiple sectors. Looking at the three-month total returns, the energy, the natural resources and the retailing sectors lead the market right now:

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However, as shown on the chart of the Fidelity Select Energy Fund (FSENX), the RSI indicator signals an overbought condition, which is often followed by a sell-off:

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We think that instead of chasing the current market leaders, investors may consider overweighting the financials sector. One of our favorite funds in this space if the Fidelity Select Financial Services Fund (FIDSX). The price consolidated in December, but the long-term uptrend was not interrupted. FIDSX is now showing signs of starting a new upleg, which we think can provide an optimal entry point for overweighting an existing position or starting a new position in this sector:

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View fund ratings at FidelitySectorReport.com for more information.

Sector Rotation: Technology at Record High; Multiple Sectors Advance

Treasury bonds sold off last week due to a sudden spike in interest rates:

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Initially, the stock market reacted negatively to the Treasury bond sell-off, but strong earnings by technology companies, such as Amazon, re-ignited the stock market rally.

The technology sector is the strongest performer right now, but the market rally is broad-based, which we think is long-term bullish for equities. Other sectors with strong momentum include materials, cyclicals, industrials, and financials.

sectors.102917

We’d like to highlight here the three leading investment funds in our survey of Fidelity sector funds, the Fidelity Select Semiconductors (technology), Fidelity Select Chemicals (materials) and the Fidelity Select Automotive (cyclicals) funds.

The charts show that the bull market advanced with virtually no interruption over the last 12 months. We think that the recent excitement about tax reform in Washington is not fully priced in yet, consequently, these investments representing the three leading sectors can continue to advance through December of this year.

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So far in 2017 investors favored high risk, high reward investments, and have been “buying on the dip”. To illustrate, we show here the charts of the Fidelity Select Defense and Aerospace (industrials sector) and the Fidelity Select Financial Services (financials sector) funds.

The arrows indicate opportunities for purchasing these investment funds after pullbacks:

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The energy, telecom, and consumer staples sectors continue to lag the market. The weakest investment in our survey is the Fidelity Select Multimedia fund that primarily invests in cable companies and content providers:

fbmpx.102917

 

Visit fund ratings at FidelitySectorReport.com for more information.

 

What to Expect in the Wake of the Global Selloff

Starting Monday, the president pushed back strongly against the nuclear ambitions of North Korea, resulting in the escalation of the conflict and increased market volatility. The VIX volatility index jumped up in response.

However, looking at the 10-year chart of the VIX, the equity market still has very low volatility and does not signal a serious geopolitical risk:

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Not surprisingly, the South Korean market responded negatively to the events, but in our view, the selloff did not break the long-term uptrend yet:

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The next question is, how much damage do we see in the US equity markets? While the selloff took market observers by surprise and many negative reports appeared in the financial media, we think that the long-term uptrend of the S&P 500 index is still intact, but it is at a tipping point:

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Furthermore, we also think that the long-term uptrend for the stock markets of the Southeast Asia region is still up, for now:

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How did the flight to safety investments perform during the selloff? First, let’s look at gold. Gold stocks rallied, but modestly. Our interpretation is that gold investors do not see a dramatic escalation of the Korean conflict yet:
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Also, Treasury yields are trending lower, which shows that the demand for US bonds, another traditional flight to safety play,  did not spike in response to South Korean threats:

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How does the chain of events impact the sectors of the market? We think that we are seeing a significant change of market leadership that was triggered by, but not caused by the Korean crisis. We also see an apparent shift in sentiment that can reinforce sector rotation.

First of all, as expected, defense and utilities, which are traditionally conservative investments, are still doing well:

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On the other hand, the price of crude oil is not improving, which leads to weakness in the energy sector:

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The selloff in technology, one of the market leaders in 2017, is modest:

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What to do next? In our opinion, the key is to follow the market-leading sectors and international investments in Europe and Asia. If they cannot recover from the selloff, we think that the whole market is in trouble, but if investors will start to buy the dip again, which worked so well for seven years, we would probably want to take a new look at the strongest sectors.

 

The sector screen used for this market analysis was provided by www.FidelitySectorReport.com.

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