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Sector rotation provides guidance

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rotation February, 2012 (Chinavestor) Major world indexes continued 2013 in January where they left off last year. The Shanghai Composite Index (SHA:000001) surged 5.1% in January, more than it advanced for all of 2012. The Hang Seng Index rose 4.7% and is up 25.7% for the last thirteen months. But advances were not limited to Chinese stocks only. The Dow Jones Industrial Average (INDEXDJX:.DJI) surged 5.8% for one month, the most since October 2011. The only disappointing performance came from US listed Chinese stocks where lack of investor confidence held back any significant price increases. We will revisit this issue in the second part of this Newsletter. All told, the China ADR Index, a market cap weighted gauge of Chinese stocks listed on the NYSE and NASDAQ and compiled by Chinavestor, eked out a mere 0.5% gain for January and is now in pair with the Dow Jones Industrial Average (INDEXDJX:.DJI) for the last 13 months.

Investors know that the superb performance of the Hang Seng Index is attributed to regained confidence that the world economy is on the way to a slow but certain recovery. Any chartist can easily pull out the Dow Jones and lay it next to the Hang Seng to see how strong of a correlation exists between the two. So when the DJIA is looking good, the Hang Seng is just as good or better due to its higher volatility.

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But investors shouldn’t be fooled by past performance. What really matters in the world of investing is what’s going to happen tomorrow. And while there is no one out there who knows for sure, looking at some key indicators could raise the level of confidence of any prediction.

Food for the skeptics: the Dow crossed the 14,000 level for the first time since October 2007. A correction looks inevitable. Also, there is a lot of uncertainty swept under the carpet. For one, retail sales (gauge of consumer spending and confidence) in Europe continue to look dim. Consumption loans point to the same direction. Considering that Greece, Italy, Spain, Portugal and Ireland continue to toil under heavy debt burden, the economic recovery in Europe looks fragile at best.

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Remember, how much drag the EU brought over to the performance of US equity markets since 2009. And looking at the US economy, the picture remains ambiguous. While consumer sentiment, housing data, and earnings all point to in the right direction, Washington continues to borrow 30-35 cents for each dollar it spends. The long term effect of such irresponsible spending is yet to be seen but one thing is for sure. Until a long term solution is found to the US debt ceiling and running budget problem, upside will not only be limited for US equities but high volatility will continue to plague the performance of US equity markets. Right now there is a two month breathing period for US equities until Washington will have another face off on the debt ceiling and fiscal cliff. This gives investors some room to take profits in the upcoming months in our judgment.

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We studied the market and its sectors since the beginning of 2010 to find patters in sector rotation. We followed the following method: we divided the 2010-2012 recovery into six months long segments starting February 2010 all the way until the end of January 2013. We omitted the recovery of 2009 since it was a reaction to a panic sell-off in late 2008. Here are our findings.

Energy, services, transportation, utilities and technology sectors have done best since 2009 while consumer stocks, basic materials and financials underperformed in the examined period. Assuming that overall market sentiment will not change for the next two months, paying a close attention to sector rotation and its dynamics can pay off.

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Utilities, and Huaneng Power Int. (NYSE:HNP) in particular, outperformed all other sectors since August 2011. The pace of advance has been slowing since August 2012 and we assume the sector will continue to cool off. Strong money flows continue to support the stock, as we pointed it out in previous Newsletters, lessening risk of a quick meltdown.

Technology stocks, especially leading internet ones like Baidu.com (NASDAQ:BIDU) and Sina Corp. (NASDAQ:SINA), recovered in 2010 but have been laggards since then. We don’t expect much upside from the sector for the next few months.

The transportation sector, dominated by airliners, recorded its strongest gains in the first six months of 2010 and it was strong again in most of 2012. More upside looks possible for China Southern Airlines (NYSE:ZNH) and China Eastern Airlines (NYSE:CEA) in our judgment.

Energy stocks recorded most of their gain in the second half of 2010 but have been lagging momentum since then. We are not that excited about the sector at this moment. Same is true for the services sector, dominated by index heavy weight telecoms. These stocks have outperformed the markets during bear markets when investors found safety in large, well established companies that have a sound consumer base.

Consumer cyclical and consumer durables come to mind when looking for sectors with little recovery since 2010. This suggests that the outlook is bright for these sectors but investors have to remember that both consumer sectors are comprised of small cap, low transparent stocks that investors have no appetite for. If anything, basic materials may bounce back strongly , giving some food for thought for companies such as Aluminum Corp. of China (NYSE:ACH). Financials, led by China Life Insurance (NYSE:LFC), had a weak start but have been gaining ground steadily since the second part of 2011. This may be another sector where patience can pay off for the upcoming months. Please pay attention to upcoming issues of our Newsletters for market timing.

Wish you successful investing,

Blaze Fabry.

 



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