The markets this year have been on a tear with the SPDR S&P 500
(NYSEARCA:SPY) posting double digit returns and defying all reasonable expectations for even a modest sell-off. Many market pundits who have been forecasting a “sell in May” scenario have been wounded by the relentless onslaught of bullish momentum. This tidal wave of optimism has benefitted some areas of the market more than others as investors have sought out sectors that are low in volatility, yet also pay a respectable dividend. One of the top defensive sectors on a hot streak this year is the Health Care Select Sector SPDR
(NYSEARCA:XLV), which has posted a year-to-date gain of 22.34% through May 13.
XLV contains some of the most widely held stocks in the pharmaceutical, biotechnology, and medical equipment industries which investors have been flocking to as an opportunity to own quality blue-chip companies with solid balance sheets. The health-care sector has been steadily advancing as rising medical costs and recession-proof demand have been a tailwind to company profits. The top three holdings in XLV include mega-cap names Johnson & Johnson
(NYSE:JNJ), Pfizer Inc.
(NYSE:PFE), and Merck & Co Inc.
The chart above shows just how far XLV has climbed over the last 12 months, where it currently sits at over 13% above its 200-day moving average. This is likely a sign pointing to this sector being overbought as we haven’t witnessed an extreme similar to this during the previous two years. Recent data from Index Universe
also suggests that institutional investors are heading for the exits on this ETF. XLV lost over $1 billion in total assets during the week of 5/6/13 – 5/10/13 which was likely a result of portfolio managers taking profits and rebalancing their holdings. Despite that data, the underlying stocks in XLV are continuing to march higher along with the rest of the stock market and the uptrend remains intact. As valuations in this sector get stretched, more investors will look to other areas of the market that present better risk to reward opportunities.
Shift to Better Value
One area where I am starting to see a shift from laggard to leader is technology stocks. The Technology Select Sector SPDR
(NYSEARCA:XLK) made a strong move during the month of April and I believe this ETF represents a better relative fundamental value than health care because it has not had the same level of price appreciation. Furthermore, the price to earnings multiples on technology stocks look much more attractive than the stretched valuations of the high-flying health-care sector. So far this year XLK has only gained 9.68%, but has picked up a great deal of momentum on the back of a shift in demand for cyclical stocks. This could be another sign of investors shunning utilities, health care, and consumer staples at these levels in favor of more growth-oriented sectors such as technology, consumer discretionary, and financial stocks. The top three holdings in XLK include mega-cap names Apple, Inc.
(NASDAQ:AAPL), Microsoft Corporation
(NASDAQ:MSFT), and Google Inc.
From a technical standpoint, XLK is only 6.8% above its 200-day moving average and still has the potential for additional price appreciation if this growth-oriented rotation continues. The true test will be whether or not the market can continue its string of new highs over the next several weeks. As we move into the summer doldrums, I would not be surprised to see a pullback in stocks which will present a better buying opportunity and work off some of the excess momentum.
Any potential correction can be used as an opportunity to shift your asset allocation into a fund like XLK that is a more attractive value play.
Read more from David Fabian, Managing Partner at Fabian Capital Management:
How Long Will Both Stocks and Treasuries Keep Climbing?
How to Diversify Your Income Streams With a Single ETF
Why I Love ETFs, and You Should Too
No positions in stocks mentioned.