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A Look at Fidelity Select Funds

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Well, I suppose there is some room for improvement...

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Breadth can be defined in an almost innumerable number of ways. We can talk about the number of stocks that advance versus decline, the volume going into those issues, high-beta stocks versus low-beta ones, etc.

Sometimes, though, it's both easier and more constructive to zoom out a bit and look at sector breadth as opposed to individual-stock breadth. Therefore, this week we're going to take a look at Fidelity Select Funds.

What is it?

We're all familiar with Fidelity, of course – it is one of the largest fund companies in existence. Over 20 years ago, in order to give investors a chance to concentrate their portfolios in certain sectors, the fund company rolled out several narrowly-based funds. Over the years, they have added to their offerings and now have over 40 funds in which we can invest.
We're all familiar with Fidelity, of course – it is one of the largest fund companies in existence. Over 20 years ago, in order to give investors a chance to concentrate their portfolios in certain sectors, the fund company rolled out several narrowly-based funds. Over the years, they have added to their offerings and now have over 40 funds in which we can invest.
The Select funds are somewhat unusual in that they make no bones about being active managers. Fidelity has been relatively aggressive in allowing their managers the freedom to target the companies they feel have the best opportunities within their defined sector. As such, Fidelity's goal is to outperform their benchmark indexes by a healthy amount, and theoretically investors get the best of breed in each sector.

Widely-respected veteran market analyst Walter Deemer popularized a look at these sector funds through publications such as Barron's. Mr. Deemer's basic take was that if a market was healthy, then a good number of these Select funds should be out-performing cash, say over the past 90 days. By watching how many funds were doing so, we could get a reading on how equities in general were faring.

Why should we follow it?

Unlike a typical advance/decline statistic, monitoring the Fidelity Select funds gives us an idea of how the very best stocks in a broad swatch of sectors are doing. We don't have to worry about a bunch of bond funds, or foreign shell companies, or doggy small-cap stocks. We're getting a pulse on the best equities available.
Unlike a typical advance/decline statistic, monitoring the Fidelity Select funds gives us an idea of how the very best stocks in a broad swatch of sectors are doing. We don't have to worry about a bunch of bond funds, or foreign shell companies, or doggy small-cap stocks. We're getting a pulse on the best equities available.
Many of the sector funds go back 20 years or more, so we have a fairly deep history. Analyzing the behavior of the funds is (mostly) straightforward, and gives us a different take than the typical breadth statistics that most everyone already follows.

The Fidelity Select indicator has timed several important market inflection points, and gives a good read on overall market health. Like most breadth figures, this data can be used in both a trend-following and contra-trend fashion by watching trends in the indicator as well as true extremes. Because it is based on closing NAV values, the raw data is publicly available and updated daily.

What are the challenges in using it?

While there are more than 40 funds now available, that wasn't always the case. So when we go back and look at some of the prior readings, we can see dramatic jumps on a daily basis because the funds were relatively few. That makes it difficult to interpret trends or have much faith in extremes.
Even today, we can see some pretty big jumps on a daily basis, so using a moving average or similar smoothing apparatus can be helpful.
It's not always clear how we should be using the indicator. For example, if 100% of the funds are outperforming cash, then is that a sign of a healthy market, or one that is hyper-extended and due for a rest? There's no simple answer to that and so taking in the broader market context is important.
By saying that we're looking at only the best stocks in each sector, we have to have a lot of faith in Fidelity's analysts and portfolio managers. The company has put a lot of money and resources behind their sector funds, but that doesn't always translate directly to good performance.
What does it look like?
What's it suggesting now?

Over the past few weeks, it might seem like I've been picking out only those indicators that are showing bearish divergences in order to drive home a point. That's really not the case – it just so happens that most of the indicators I follow are showing very unusual readings that are not typical of a market hitting new highs.
This is yet another one. Only 46% of the Fidelity Select funds were outperforming the return on short-term Treasury paper on Friday. This is a dramatic divergence considering the S&P 500 closed at a new three-year high.
We'd have to go back to March 23, 2000 to see the last time the S&P hit a new yearly high and fewer than 50% of sectors were better than cash. We saw a similar divergence in July 1987, but I don't want to give the impression that this is a "market crash" signal. There were other divergences, like 1995, that actually led to excellent market gains, but again I think context is important here…seeing wide divergences in the number of good stocks that can't even beat the return on cash doesn't seem like a real healthy market to me, and for the most part history backs that up.
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No positions in stocks mentioned.

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