Sector Rotation: Is it Time to Take Profits in High-Soaring Media Stocks?

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.

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Chart 1.

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:

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Chart 2.

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:

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Chart 3.

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U.S. Equities are in Overbought Territory and Vulnerable to a Large Correction

U.S. equities have been making new highs almost daily and 2013 is clearly shaping up as one of the strongest bull markets of recent market history. But how dangerous is this market for investors looking to commit new capital?

The chart below shows the 15-year performance of the Fidelity Spartan U.S. Equity Index Fund (FUSEX) using monthly bars. This long-term chart shows that the great bull market of 2013 is still intact and has advanced without any serious interruption since December 2012.

However, a closer look at the RSI indicator (a technical indicator that measures overbought/oversold conditions) on the top of the chart shows an overbought condition. While the bull market can continue its positive momentum for weeks or months, U.S. equities are increasingly vulnerable to a serious correction or even a crash.

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