Waiting on a Trend: Sector Leadership in the Current Market
It has been well documented in recent years that active portfolio management, in general, has faced a number of performance challenges. Contributing factors include low volatility levels, global central bank intervention, and continued increases in market efficiency. For trend-based investment strategies in particular, another impactful factor has been an increased variability in sector leadership.
Trend-based strategies thrive on strong market leadership. As a simplistic example of this principle, if an investor can rely on utilities to be the best performing sector every month, and on materials to be the worst performing sector every month, a simple strategy of buying utilities and avoiding (or shorting, if possible) materials will outperform the broader index. If utilities and materials frequently and randomly trade spots as the best and worst performing sectors, the investor will likely struggle to be appropriately positioned.
One way we can measure market leadership historically is by ranking the sector returns every month. If we then measure the changes in ranks from month to month, we can run the standard deviation of these changes to give us an indication of how variable the ranks are. For example, a standard deviation of zero means that there were no changes in performance ranks from one month to the next. Higher standard deviations mean more drastic ranking changes, indicating lower stability of market leadership.
If we then calculate and track the 12-month trailing average of the monthly values (to reduce some of the noise in the data), we can see an interesting recent development:
Source: Bloomberg data, compiled by Rampart Investment Management.
This view of market dynamics highlights the extent of the current investment challenge. Variability in market leadership is higher than it has been since 2000, which creates enormous challenges when attempting to identify and profit from trends. What we see above is just one aspect of what has been referred to as a "trendless market."
If any comfort is to be found in this data, it is that we do not see any general upward trend in variability levels over the long term, and that previous spikes have generally been short-lived. It is, therefore, our expectation that a more normal market in terms of sector leadership will emerge in due course.
Past performance is not a guarantee of future results.
Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.