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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A Bullish Case for the Market: The Strongest Sectors are Getting Stronger

Summary

  • While the S&P500 index pulled back in the last six weeks, the leading sectors continue to advance.
  • We expect to see additional trading opportunities in the next few weeks in the technology, utilities, cyclicals, consumer staples, and industrials groups.
  • Our technical screen shows that real estate and health care can also strengthen.
  • It is best to avoid weak sectors that continue to weaken, such as energy and financials.

 

The benchmark S&P 500 index pulled back from its all-time record since early March, but volatility stayed low in spite of geopolitical uncertainties in Syria and on the Korean peninsula. In our view, any improvement in the outlook for tax or regulatory reform in Washington can serve as a catalyst to spark a broad-based stock market rally.

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In the section below we review the strongest industry groups that we think are worth watching closely in the next few weeks.

Technology: The strongest sector fund in this group is the Fidelity Select Technology Fund (FSPTX). FSPTX has been one of the best performing Fidelity funds in the last 12 months and it continues to advance:

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Utilities: The Fidelity Utilities Fund (FSUTX) is regarded as a conservative investment, but has appreciated in price considerably due to interest rates trending lower:

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Cyclicals: Economists usually rejoice when consumers increase their spending on goods and services since it shows that the economy is on a strong footing. One of our favorite investments in this space is the Fidelity Select Leisure Fund (FDLSX). FDLSX has turned from a market performer to an outperformer in the last two weeks and the technicals continue to be very bullish:

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Industrials: We highlight only the Fidelity Select Defense and Aerospace Fund (FSDAX) here as one of the top investments in this space, but we think that the whole industrials group can be interesting going forward.

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Consumer staples: Another conservative investment and can generate solid returns:

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Weak sectors, which are underperforming the broader market include the Energy and the Financials groups. Here we show two examples, the Fidelity Select Energy Services Fund (FSESX) and the Fidelity Select Banking Fund (FSRBX). Both funds are below their respective 100-day moving averages and show a negative price pattern:

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The Stock Market Rotates in Slow Motion; Low Volatility Continues

Our benchmark investment, the Fidelity Spartan 500 Index Fund (FUSEX, last change: 0.15%) was up slightly today and made a new 52-week high. 50% of Fidelity’s sector funds gained today following the index. The other half of the funds pulled back, but the daily moves were small.

The salient feature of the current market environment is its unusually low volatility. The lack of bad news from Europe, the Middle East and Washington combined with the money flow from bonds to stocks and the Fed’s stimulus package make the equity market appear less risky than in previous years. We know from market history that the low volatility will likely end soon, but for now we can all enjoy this uniquely peaceful market.

The sector rotation that often occurs in January has started, however the sectors move up and down at a slow pace. Top investments of 2012, such as biotechnology and international real estate, have retreated slightly (see charts below).

Investment areas with positive momentum include technology, energy services and blue chip stocks. The most out-of-favor sector remains gold mining stocks.

The Fidelity Select Biotechnology Fund (FBIOX, last change: -0.74%) has pulled back slightly from its recent high.

The Fidelity Select Biotechnology Fund (FBIOX, last change: -0.74%) has pulled back slightly from its recent high.

Fidelity International Real Estate Fund (FIREX, last change: -0.21%)

Fidelity International Real Estate Fund (FIREX, last change: -0.21%)

 

Fidelity Blue Chip Growth Fund (FBGRX, last change: 0.43%)

Fidelity Blue Chip Growth Fund (FBGRX, last change: 0.43%)

Fidelity Select Technology Fund (FSPTX, last change: 1.03%)

Fidelity Select Technology Fund (FSPTX, last change: 1.03%)

 

Buy/sell signals for Fidelity funds are available at FidelitySignal.com.