Does the bounce have legs? That’s the key question these days as US equity markets rebound from the correction that’s dominated much of the year to date. The obvious caveat: the catalysts that led to the risk-off sentiment are still lurking, namely: high inflation, rising interest rates, slowing economic growth and heightened geopolitical risk linked to the war in Ukraine. US-China tensions are also a factor as Beijing conducts provocative military drills around Taiwan.
For the moment, Mr. Market appears to be looking through these issues. Has the worst passed for equities? That strikes me as premature, but a revival in positive momentum readings leave room for debate.
Looking at US shares through a sector lens certainly shows a new run of upside strength. The utilities sector (XLU) is particularly strong at the moment via a +5 Signal score, the highest-possible reading for this proprietary indicator (for details on the methodology, see this summary).
Utilities, of course, are a relatively defensive slice of the equities market and so caution is advised for using this sector as a sign that all is well again. But there are also relatively strong readings in other sectors, including consumer discretionary (XLY) and consumer staples (XLP), which are just one notch behind XLU’s bullish score.
Tech (XLK) is also showing a new run of strength after an extended slide.
Sectors with the strongest Signal scores look set to extend their upside bias. That’s still a contrarian view, given the macro and geopolitical backdrop. But on a tactical basis, there’s a case for expecting these slices of the equity market to continue leading.
On the flip side, the energy sector (XLE) has run into turbulence after a stellar run. This sector now stands out for its relative weakness: XLE is currently posting the lowest Signal score in the table above: a moderately bearish -2.
It appears the market is in the middle of a sector rotation reshuffling. That’s usually a messy process and no less is likely this time. Then again, it’s not obvious that new leadership will quickly deliver large positive returns. In a world pulsing with macro and geopolitical threats, there’s a decent chance that relative outperformance will translate to losing less for the near term. ■