Momentum, Thy Name is Healthcare?

When I say the word “momentum,” what’s the first sector that comes to mind?

I’m guessing it wasn’t Health Care. Looking at today’s market, though, there is no question about it – healthcare has become a momentum sector.

We can see this clearly in looking at the largest momentum ETF from ishares (MTUM), which now has almost a third of its portfolio in Health Care names.

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This is significantly larger than Health Care’s weighting in the S&P 500 of 14%.

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The momentum ETF chooses its holdings by evaluating “each stock’s 6-month and 12-month risk-adjusted excess returns.”

Using this methodology, it should come as no surprise that Health Care is the top weighting as it has been the best performing sector in the market this year (see chart below). It also should come as no surprise that there is only a 1% weighting to Energy as it is the only sector with negative performance in 2014. What is surprising is the relatively low weighting (1.79%) to Utilities, which is the second best performing sector this year.

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Of the top twenty names in the momentum ETF, eight are in the health care sector, including Johnson & Johnson (JNJ), Gilead (GILD), Amgen (AMGN), Celgene (CELG) and UnitedHealth (UNH). Technology is also a big portion of the index, mostly from large cap holdings in Apple (AAPL), Microsoft (MSFT), Intel (INTC), and Facebook (FB).

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The top performing health care names in the ETF include Intuitive Surgical (+149%), Allergan (+103%), Actavis (+99%), Illumina (+79%), Edwards Lifesciences (+68%), and Amgen (+60%). Biotechs are highly represented in this list.

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Concluding Thoughts

Health Care is now an important part of the equity momentum factor given its outsized performance relative to the broad market over the past year. As momentum is an objective process, it will remain a large factor as long as it remains a top performer. Should we see a reversal in health care strength, it will have more sizable negative impact to momentum-leaning portfolios today than in prior periods given its larger weighting.

We saw this early in the year when Biotechnology stocks were hit hard (see black line in chart below) in March and April. They have since rebounded to new highs and over the past four years biotechs have outperformed the S&P 500 by an astounding 84%.  The health care sector in general has outperformed the S&P by 34%, also a sizable margin given that the sector is usually considered “defensive” and we are still in a bull market and economic expansion.

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Will the outperformance, particularly in biotechs, continue in 2015 or is it time for another sector to emerge as a leader? Perhaps we should ask Janet Yellen who still has a “sell”  rating on the shares.

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This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

 

 

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The New Tech: Changing Sector Behavior Over Time

Industries change. Companies change. Valuations change. It should come as no surprise, then, that sector behavior in the stock market can change as well.

Let’s take a look back at the ten S&P 500 sectors since data became available in October 1989.

Defensive vs. Cyclical

We generally break down the sectors into two main categories based on annualized volatility (see chart below):

  • Defensive sectors: Utilities, Consumer Staples, and Health Care
  • Cyclical sectors: Telecom, Energy, Industrials, Consumer Discretionary, Materials, Financials, and Technology

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Changing Technology

However, this chart doesn’t tell the whole story. Technology has been the most volatile sector on average since 1989 but that volatility has been far from constant. Is Tech the same sector today as it was back in 2000?

As it turns out, it not even close to the same. The top five weightings in the Technology sector today (comprising 40% of the index) are Apple, Microsoft, Intel, Google, and IBM. All of these are well-established companies with real earnings and valuations more closely in line with the broad market, a much different picture than what persisted in the late 1990’s and 2000.

According to Patrick O’Shaughnessy of O’Shaughnessy Asset Management, the percentage of “cheap” companies that are in the Tech sector is higher today than almost any other period in history (see yellow in chart below)

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Source: Millenial Invest

As a result of this and the increasing perception of safety given its high cash levels, Tech now has the lowest volatility of any of the cyclical sectors. In the chart below, you’ll notice technology volatility (green line) started deviating from the rest of the cyclical sectors in the late 1990’s as the “dot-com bubble” took hold.

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As the bubble burst, volatility slowly moved back in line with the other cyclical sectors and in recent years it has taken a more defensive tone. In fact, over the past 24 months it actually has the lowest volatility of any sector, even lower than the three defensive sectors.

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Changing Financials

Another notable sector with a significant change in behavior has been Financials. After exhibiting low volatility from 2002-2006, its volatility began moving sharply higher in 2007. During the financial crisis and its aftermath, it was by far the most volatile sector (see red line in chart below).

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Today, like Technology, Financials are behaving in a more defensive fashion. Leverage and risk in the sector has declined and the perception today is that these are more stable companies with stronger balance sheets.

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Changes to Come

What sectors today should we keep an eye on for a potential shift in behavior?

Energy is an obvious choice based on the sharp decline in Crude in recent months and indeed it has been by far the most volatile sector this year.

I would also watch the Health Care sector more closely here. Its beta has been steadily rising over the past two years as the higher volatility Biotechnology stocks have become a more important driver of returns.

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Concluding Thoughts

Sectors change over time and their behavior in the stock market changes as well. Monitoring these changes are important for investors as sector volatility is a key driver of overall volatility in most equity portfolios. It can also be important from a signaling standpoint, as heightened volatility in Technology and Financials were precursors to significant declines in these sectors and eventually the broad market as well.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

 

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A 5% Correction and QE4 Talk Begins

Over the past eleven days, the S&P 500 has declined a little over 5%. This is now the 17th correction of greater than 5% since March 2009.

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As has been the case over the past few years, this minor short-term pullback has already led to chatter of a more dovish Fed to come. Many market participants are now calling for an extension of the “considerable time” language, and if the decline should continue, a fourth round of QE in 2015.

But we just finished QE3 in October, you say, and the economy has shown positive payrolls for fifty consecutive months, the longest streak in history. Why would market participants be talking about more Fed stimulus when we just saw a monthly jobs number of 321,000?

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As I outlined in a recent piece, it is not economic data that is driving Fed policy but the short-term machinations of the stock market. In the name of the “wealth effect,” to the Fed the stock market has become the economy.

We can see this clearly in looking at the Fed Funds Futures curve over the past 11 days. Expectations for 2015 rate hikes have already been pushed out, with most now expecting the first hike to occur in September 2015.

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Even if we accept that stock prices are driving monetary policy, is a 5% correction really enough to generate QE4?

Probably not, if history is a guide. After the end of QE1 and QE2 in 2010 and 2011 it took declines of 17% and 21% respectively to bring about new Fed programs. Asking for QE4 when the market has only declined 5% from an all-time high seems a bit premature.

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That said, this is the key market dynamic as we enter 2015, a continued dance between the short-term movements in the stock market and the Fed. As long as the Fed is targeting another bubble in stocks in the name of a “wealth effect,” we can expect this dance to continue. Should they choose to stop dancing, they will have to be prepared for market participants to stop dancing as well. I’m not sure that’s something they are willing to leave to chance.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Edward M. Dempsey Pension Partners New YorkCharlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts.  He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.

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