The leaders in relative strength versus the overall market have stayed consistent throughout this year. It has been those technology-heavy sectors, along with Homebuilders, that have remained the market’s strongest components. While technology-oriented sectors have held the top spots on relative strength leaderboards, those sectors that are often considered “defensive” have hovered from the middle to the bottom of the sector relative strength rankings.
Throughout these market commentaries, we have repeated that the market’s sector weightings are unbalanced and top heavy. While technology has inflated the strength of the S&P 500 index, it has also understated the weakness of other sectors.
In this update, we are going to use the Health Care sector as an example of how capitalization weightings can work against a sector’s strength. Of the eleven S&P 500 sectors, Health Care is currently ranked second-to-last in risk-adjusted strength. Unlike the technology-oriented sectors, Health Care’s largest securities are holding the sector back.
Here is a quick study on Health Care stocks. For this study, we will be using Canterbury’s Volatility-Weighted-Relative-Strength, which is a risk adjusted ranking, as well as Canterbury’s Buy/Hold/Sell indicators, which are composed of volatility and other common technical indicators.
The Health Care sector is composed of 65 company stocks. Looking at the individual stocks, 37 of them have a “Buy” rating, 16 have a “Hold” rating, and 12 have a “Sell” rating. On the surface, it looks like more than 50% of the sector is a “Buy.” Remember, sectors are capitalization weighted. While more than half of the stocks have a “Buy” rating, those stocks only account for 18% of the sector’s market capitalization. Meanwhile, the twelve stocks that are “Sells” make up 31% of the sector’s capitalization.
Source: Canterbury Investment Management. Sector weightings data from XLV holdings. Buy/Hold/Sell indicators are objectively computed using Canterbury’s combination of technical indicators.
Health Care’s largest stocks happen to also be its weakest ones. None of the largest 6 stocks within the sector have a “Buy” rating. Those same 6 stocks make up 39% of the sector. Looking at the largest 20 stocks, only 6 of them are ranked in the top half of the sector on a risk-adjusted basis. So, while a majority of the Health Care stocks do have “Buy” characteristics, the sector appears near the bottom of our ranking because of the impact of its weak larger securities.
Bottom Line – A Note on Market Opinion
As I was writing this update and conducting the study on Health Care stocks, Yahoo Finance sent my phone a push notification. The notification was for an article titled “Goldman Sachs Lowers Recession Forecast as “Goldilocks” Debate Heats Up.” The gist of this article was that Goldman Sachs has lowered their estimated probability of a recession to a mere 20%.
Economists have gone back and forth on the likelihood of a recession, often going from one extreme to another. A little over a year ago, a Goldman Sachs senior chairman stated the opposite, asking for companies and consumers to “brace for an imminent recession in the US.”
As Yogi Berra once said, “It is difficult to make predictions, especially about the future."
The problem with investing today is that important decisions are being made based on expert opinions and predictions about the future. Even if those predictions are correct, there is no reason to believe that they will be right on future predictions. Therefore, it is only a matter of time that implementing a subjective form of investing will eventually prove to be harmful to your financial health.
At Canterbury, our investment process is not based on changing predictions and opinions. It is based on proven rules and systematic processes. These rules and processes are directly connected to what drives market prices- the law of supply and demand. We cannot predict the future, but we can assess the efficiency (as measured by volatility) of the markets right now. What we know for a fact is that bear markets are volatile. When indicators show that volatility is increasing, the market is becoming less efficient. An adaptive portfolio must be able to adapt its holdings in order to move in concert with the ever-changing market environments. The goal is to protect against the potential for a future significant decline. To be successful at managing risk, your portfolio must be able to optimize its holdings for the current market conditions.
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