Intrasector Dispersion and Momentum Strategies

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With Monday's (7/20) intraday price action, the default Point and Figure chart of the S&P 500 Index (SPX) broke a spread quadruple top with a move to 3240 before moving higher to 3270 on Tuesday. This latest buy signal marks the third consecutive on the chart, confirming that demand is in control. Although SPX gave up some of its gains over the last few days of trading, we note that the Index remains above initial support offered at 3200 and sits approximately 5.44% off of its all-time high from February. Because of its recent bullish price action, the Index itself moved back into positive territory for the year with a gain of 0.15% through 7/23, although it is toeing the line with today's intraday action. When we look at performance through a sector lens using the SPDR sector fund lineup as proxies, we find that as of this writing, five of the 11 broad sectors are in positive territory for the year. Currently, the dispersion between the best (technology) and worst (energy) performing sector is 53.35%.

When we refer to heightened dispersion, which is best quantified by the performance difference between the best and worst-performing sectors or asset classes, we are ultimately describing the increased opportunity available through the application of tactical strategies. Relative strength-based approaches, like those offered by Nasdaq Dorsey Wright, tend to offer excess return over their benchmarks more readily when the dispersion between the best and worst performers is extensive. The reason for this is relatively straightforward: The more divergence that exists between the best and worst-performing sectors (or asset classes), the more potential value an advisor can add by owning those areas of the market that are performing well while avoiding or underweighting the weaker sectors. Wide dispersion creates more potential for a tactical decision to produce a meaningful result. On the other hand, such strategies will tend to suffer or at least become muted when the dispersion is narrow. As an extreme example, if all investment possibilities were up the same amount each month and each year, there would not be much, if any, value for a tactical manager to add via rotation. With that in mind, we wanted to take a more in-depth look into the dispersion within each sector. By examining intra-sector dispersion, we aim to identify the areas of the domestic equity market where momentum strategies are likely to offer the most significant advantage over simple beta exposure.

Using the 11 broad SPDR Select Sector ETFs as proxies, we ran the year-to-date numbers through 7/23 for all of the constituents within each sectors' respective basket to determine the best and worst-performing stock within each. As the chart above shows, the consumer discretionary sector has the most extensive year-to-date dispersion reading at just over 136.95%, followed by the technology sector at 126.61%. In comparison, the third-widest dispersion reading comes from the healthcare sector at 117.08%. Based on our intra-sector dispersion examination, we would conclude that consumer discretionary, technology, and healthcare are the sectors that currently offer the most significant opportunity for relative strength strategies and, therefore, will be the focus of the rest of our discussion.

Dorsey, Wright & Associates, LLC, a Nasdaq Company, is a registered investment advisory firm. Registration does not imply any level of skill or training.

The Sector Dispersion chart was created using the holdings of each of the Select Sector SPDR ETFs: The Consumer Discretionary Select Sector SPDR (XLY), Energy Select Sector SPDR (XLE), Healthcare Select Sector SPDR (XLV), Technology Select Sector SPDR (XLK), Communications Services Select Sector SPDR (XLC), Materials Select Sector SPDR (XLB), Consumer Staples Select Sector SPDR (XLP), Financials Select Sector SPDR (XLF), Industrials Select Sector SPDR (XLI), SPDR Dow Jones Real Estate (RWR), Utilities Select Sector SPDR (XLU).

Unless otherwise stated, the performance information included in this article does not include dividends or all potential transaction costs. Investors cannot invest directly in an index. Indexes have no fees. Past performance is not indicative of future results. Potential for profits is accompanied by possibility of loss.

Nothing contained within the article should be construed as an offer to sell or the solicitation of an offer to buy any security, nor as a recommendation to engage in any transaction or participate in any strategy. This article does not attempt to examine all the facts and circumstances which may be relevant to any company, industry or security mentioned herein. We are not soliciting any action based on this article. It is for the general information of and does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any analysis, advice or recommendation (express or implied), investors should consider whether the security or strategy in question is suitable for their particular circumstances and, if necessary, seek professional advice.

© Nasdaq Dorsey Wright

© Nasdaq Dorsey Wright

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