Stock Sector Signals
Utilities, Consumer Discretionary, And Watch The Banks
“If one does not know to which port one is sailing, no wind is favorable.”
A key element of investing is analyzing the internal workings of the markets. The correlations, volatility, volume, and many other factors decribe the environment the markets are responding to in real time. Understanding what the market is doing enables investors to flow with what the market wants to do. Nothing else can help you be more consistently profitable over time.
Being a constant student of the markets enables you to view the interaction between your own investment thesis and how the market is behaving. This is a key relationship that goes both ways. Markets provide real time feedback on your thesis, enabling you to either develop and fine tune your thesis, or adjust your thesis to another idea that more closely matches what the market is doing.
As discussed in these Best Investor Weekly Insights, I have been working on the thesis that growth is slowing in Q1 and Q2 of 2022, and with a delay inflation is near to at least a temporary peak. This most closely fits a “Quad 4” allocation environment.
It is worth checking this thesis with current market behavior.
Utilities should perform well in a Quad 4 envitonment. High quality bonds typically perform well when inflation and growth are declining, and utilities have similar characteristics. The chart below shows that utilities have indeed performed well over the last 6 months, even though Treasuries have performed badly. Furthermore, utilities have also outperformed the high beta Nasdaq index, and in addition the small cap Russell 2000, both of which would likely outperform utilities outside a Quad 4 environment.
Utilities are Confirming Quad 4 Market Conditions
Further Quad 4 confirmation comes from the substantial outperformance of consumer staples over consumer discretionary stocks. This is what should be expected. As growth slows consumer staple spending holds up relative to discretionary spending. XRT has been an exceptionally good hedge for an equity portfolio and yet it still stands far above the February 2020 highs.
This kind of analysis can also be helpful as regards sending warnings signals that investors may want to see confirmed or invalidated before taking allocation decisions. Banking stocks have just recently significantly underperformed the S&P 500. The chart below shows that BKX has just made three lower highs and lower lows significantly underperforming the S&P 500.
For some time the banking stocks have provided advance notice of significant drawdowns in the S&P 500. This is shown in the chart below and in more detail in the attached video.
The significantly high probability of a deep quad 4 in Q2 2022 has been so clear for so long that I stated it on video as a 95% chance in my October 2021 Money show presentation.
Hedgeye’s cycle accuracy has once again provided a significant edge to timely investment allocation.
My Track Record Over the Last 6 Months in These Insights
Money Show (October 20, 2021)
I explained the key inflation predicament we are in, which continues today.
I also indicated why the US stock market rally was not quite over yet.
Then the rally in S&P 500 continued into year end.
I also provided a 6 month warning, that a reversal was coming, and risk management would become essential. I also demonstrated risk management techniques.
I have remained on track with the evolving market developments ever since with my “Best Investor Insights” blog chronicled on my web site.
Inflation Policy Extreme. Reflation for now. (October 25, 2021)
2022. The Banquet Of Consequences. (December 2, 2021)
“A rising rate of change in both growth and inflation (quad 2), in place for most of 2021, has ended. The outlook is some combination of “goldilocks” (quad 1) or “deflation” (quad 4). Make sure your allocation is shifting appropriately.”
Growth Stocks Or Gold Miners? (December 31, 2021)
This was a near perfect call. Look at QQQ versus GDX.
“Investors should consider that for well over a year the economy experienced very strong reflationary quad 2 conditions. This is great for growth stocks and bad for gold. However, quad 2 ended with 2021.
Policy is now turning less stimulative in 2022, and both inflation and growth are likely to reverse down. Quad 4 currently has a 90% probability in Q2 2022. Gold does much better than growth stocks in quad 4, especially when policy is tightening.
There is significant risk of a continued broad sell off in growth stocks that may be accompanied by a significant rally in precious metals stocks. How the Fed responds will be a key factor but this is an important time to consider a significant reallocation.”
In 2022 Gold is substantially outperforming growth stocks (like the QQQ Nasdaq ETF).