The market strategists split when it comes to the recent rally within the S&P 500’s weakest sectors for this year. While there are some that believe it is the bull market gaining a second wind, the others are stating that it is a bear rally.
Since the Dow Jones Industrial Average (DJIA) is up by 0.16% and the S&P index (SPX) is up by 0.15%, the Nasdaq Composite Index (COMP) is down by 0.24%, and all of them exiting correction territory, it has come to no surprise that the worst sections of the correction happen to be the leaders now.
Historically speaking the worst sectors have normally outperformed the broader market 6 months after a bear market or correction.
Since the stocks are posting slight gains, materials and energy have pared their October gains and were the worst performers since crude oil prices dropped. The sectors although remained the best performing for the month with materials gaining 9%, industrials up by 7% and energy stocks up by 10% when compared with S&P 500 gain of 5%.
For any investor that wants to leverage history on a sector level should go to the exchange trade route with the materials sector SPDR ETF XLB down by 0.73%, Energy sector SPDR ETF XLE down by 0.06%, while the industrial sector ETF XLI down by 0.02%.
Out of those three sectors, the material sector might be the most promising. The person that maintains S&P 500 stated that cyclical stocks, such as materials and energy, were oversold; short sellers stepped in to cover up the shorts, and then a degree of confidence for those riskier assets returned to the market.
It was recommended to use the materials sector as a proxy for any commodities, because it gives you exposure to firms that produce and explore basic materials like copper, gold, and iron ore, but it also has companies that process them.
Weak sectors has led to a bear rally
There have been strategists that have seen a rally led by the weakest sectors as a real red flag.
A rally in sectors that happen to be vulnerable to macro risks, such as industrials and energy, give a poor foundation to the broader market.
With the recent rally, energy stocks – the best performers in the recent days – are now officially overpriced as the oil prices have climbed back from the lows of August.
For the energy stocks to be able to sustain a forward 12-month price to earning ration of 15x, the oil prices would have to be around $65 per barrel in 2016. That is too optimistic, given wider credit spreads as well as uncertainties that surround global growth, currencies and commodity prices.
The recent bounce back for the weakest sectors in S&P 500 looks like a bear trap. The bull rally was led by health care growth, consumer and tech discretionary. Now it’s peeled away and looks like a bear rally led by the weakest sectors.