According to economic cycle theory, the economy follows a regular cycle moving from recession to recovery, and back into recession over a period of several years. Historic studies have shown that when the economy starts to recover from a recession, the consumer discretionary sector (cyclicals) is often the first to make gains closely followed by technology and industrials.
While we have not had a recession since the stock market low in 2009, the strong performance of the technology, consumer cyclicals (see Chart 1.) and industrials sectors in the last six months have raised the possibility of starting a new market cycle without a serious correction.
Starting a new market cycle without even a relatively small correction is a possibility, but would be very unusual. That is why we are on the lookout for early signs of a market pullback.
One of the cautionary signs is that media stocks, an important sub-sector of the consumer discretionary sector, reversed their uptrend today (see downgrade by FidelitySectorReport.com) due to multiple companies reporting a significant fall in advertising revenues:
The strongest sub-sector in the consumer discretionary space now is the leisure sub-sector (see Chart 3.) with names like Starbucks, Las Vegas Sands, and Marriott. We think that leisure stocks are long-term bullish, but short-term overbought, ready for a pullback:
After high market volatility in 2015, it is not surprising to see that investors are favoring conservative investments in 2016. We’d like to highlight here a trio of conservative sector funds, which show improving relative strength compared to the S&P 500 index.
The Fidelity Select Utilities Fund (FSUTX) returned an impressive 14.5% in the last three months, surpassing the 2.77% return by the benchmark Fidelity Spartan 500 Index Fund (FUSEX) in the same period:
The Fidelity Select Telecomm Fund (FSTCX) is at a new all-time high level and returned 10.17% in the last three months:
The Fidelity Select Consumer Staples Fund (FDFAX) reached an all-time high too, and returned 6.32% in the last three months:
After the market turmoil in the second half of 2015, new trends have emerged in 2016. One of the important new trends is that the long-term Treasury yield index reversed direction and going lower:
Lower long-term interest rates coupled with the strengthening U.S. economy makes bond investments attractive again. The Fidelity U.S. Bond Index Portfolio Fund (FBIDX) is a great way to participate in the new investment environment, because FBIDX invests in both Treasury and corporate bonds.
One of our long-term favorites is the Spartan Municipal Bond Fund (FHIGX). This fund has been making steady gains since October 2015 and we believe that the improving economy should continue to strengthen the credit worthiness of issuers and increase demand for municipal bonds.
A technical screen of Fidelity mutual funds shows that new investment areas emerged in 2015 to lead the market
The natural resources sector, which includes energy, has the potential to provide market-beating returns. On the other hand, investors shouldn’t expect low volatility, because commodity prices can fluctuate in a wide range
International markets, most notably Asia and Europe, may outperform U.S. equities this year
From time-to-time, it is important to take a broad view of the market, so we can better understand the changing conditions and dynamics. Five month ago, back in November 2014, our momentum screen showed that the top 10 Fidelity mutual funds were all equity funds representing the consumer, health care and transportation sectors of the U.S. economy (see article).
While equity funds continue to outperform bond funds, the picture is very different now. Mutual funds investing in energy and other natural resources, and international markets are the market leaders. At the same time, select U.S. sectors, such as utilities, are lagging:
Speculation about bottoming oil and commodity prices have caused an impressive rally in the natural resources sector. A great way to participate in the potentially long-term bullish trend in this sector is via the Fidelity Select Natural Resources Fund (FNARX).
The Fidelity China Region fund (FHKCX) is now the best year-to-date performer of all Fidelity mutual funds with a 20.97% gain.
Quantitative Easing in Europe and in Japan has started to make a positive impact on equity prices in developing markets. In our view, one of the best ways to participate in this long-term trend is by investing in the Fidelity Diversified International Fund (FDIVX). FidelitySignalissued a BUY signal for the fund on February 8 and the fund was included in our Diversified Model Portfolio, as of that date.
The potentially stabilizing U.S. dollar and commodity prices, and the prospect of world-wide economic recovery in 2016 are making emerging market investments attractive again to investors seeking growth.
The Fidelity Southeast Asia Fund (FSEAX) provides a solid way to participate in the Chinese and other Southeast Asian markets. FidelitySignalissued a BUY signal for the fund on January 23 and the fund was included in our Aggressive Growth Model Portfolio, as of that date.
For investors seeking broad diversification across emerging markets including Southeast Asia, Eastern Europe and Latin America, the Fidelity Emerging Markets Fund (FEMKX) is our top rated choice. FidelitySignal issued a BUY signal for the fund on April 7 and the fund was included in our Megatrends Model Portfolio, as of that date.
The chart of the Fidelity Spartan U.S. Equity Index Fund (FUSEX) shows that U.S. equities broke out from a volatile trading range that started in early December of last year. At the same time, the yield of Treasury bonds reversed course, which caused the Spartan Long-Term Treasury Bond Fund (FLBIX) to correct:
Mutual funds investing in the leading sectors have continued to advance this year, but may be ripe for a pullback now to their respective moving averages (blue lines on the charts):
As the equity market has turned more bullish again, sector rotation has intensified, as well. This is good news for investors, since new investment opportunities are emerging. One example is the Fidelity Select Materials Fund (FSDPX):