Can Energy and Defense Stocks Rally Following the Allied Airstrike in Syria?

Defense stocks surged on April 7, following the first U.S. strike to punish the Syrian regime. We think that we will likely see a similar response by investors following last night’s airstrike on chemical weapons facilities in Syria.

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The Fidelity Select Defense and Aerospace Fund (FSDAX) has outperformed the broad market for more than a year. We anticipate that the strong trend will continue in the wake of allied airstrikes in Syria.

 

We also think that the increased risk of escalation of the Syrian conflict and the potential for disruption of oil production could lead to higher oil prices and the continuation of the bullish rally for energy stocks.

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The price of the West-Texas Intermediate Crude Oil (WTIC) could reach the $70 per barrel mark next week in response to increased geopolitical risks.

 

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The energy sector experienced a 20% correction at the beginning of 2018 but seems to be recovering again in response to higher oil prices. The Fidelity Select Energy Fund (FSENX) could be a great way to play this trend.

 

View fund rankings at FidelitySectorReport.com

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Stock Market Correction Continues with a New Wave of Selling

The stock market started the second quarter with heavy selling. The S&P 500 index dropped by more than 2%:

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Technology and consumer discretionary stocks led the sell-off, including Intel (down -6.07%), Amazon (down -5.21%), Netflix (down -5.10%) and Facebook (down -2.75%).

Not surprisingly, mutual funds with large holdings in these names declined the most today:

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Investors were selling other high-risk assets too, such as biotechnology shares:

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With the dollar no longer falling versus the major currencies, international investments in Europe and Asia are becoming less attractive, as well:

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Remarkably, all sector funds closed down today. In our view, this rare occurrence may signal a significant shift in investor sentiment towards a more bearish stance.

The momentum rankings of Fidelity sector funds show that the defense sector and some sub-sectors of technology are the strongest relative to other sectors:

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Furthermore, the charts below show that both the Fidelity Select Defense and Aerospace Fund (FSDAX) and the Fidelity Select IT Services Fund (FBSOX) stayed above their respective 100-day moving average.

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We use the 100-day moving average to assess the direction of seasonal, or intermediate-term, trends. The only other Fidelity sector fund that is above its 100-day moving average is the Fidelity Select Utilities Fund (FSUTX):

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Overall, in our assessment, most sectors that make up the U.S. stock market are turning bearish in the short to intermediate-term timeframe, which could lead to further downside risk.

 

View fund rankings at FidelitySectorReport.com

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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:

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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.