We’re a little more than 2 months into the new year, but if you look at sector leadership, you might think we’re still stuck in 2023. Information Technology and Communication Services are each up double digits for the year, pacing the 8% year-to-date gain for the S&P 500 index.
We’ve spent most of this year watching and waiting for a rotation out of those big growth sectors and into the value-oriented laggards of 2023. While a full-on rotation hasn’t materialized - at least not yet - those other sectors haven’t done too bad. The Industrials and Health Care sectors have both broken out to new all-time highs, and the Financials are knocking on the door. All three are keeping up with the benchmark S&P 500, too.
The big laggards in 2024 are the risk-off, yield sensitive areas of the market. Utilities and Real Estate are both negative for the year.
That’s not such a bad thing. The risk-off areas should lag during bull markets. That’s evidence of risk appetite, and risk appetite is what drives prices higher.
Hold on though, Health Care is risk-off, too, right? We hear that all the time, and it passes the fundamental smell test. The revenues and earnings of Health Care companies tend to be less cyclical, making them a preferred area for investors to hide during economic uncertainty. But that doesn’t tell the whole story.
Take a look back at the 1990s and the dotcom era. Sure, by the time everything came unwound in the spring of 2000, Tech was the only thing that mattered. But up until the start of 1999, Health Care was tracking the Tech sector step-for-step.
And for the bull market that raged from the 2011 lows until the summer 2015 highs, Health Care was the outright leader.
Does any of that mean Health Care must be a leader? Of course not. There are plenty of bull markets where it’s lagged. But Health Care can be a leader in a bull market, despite the popular narrative that it’s a risk-off sector.
We think they’re positioned to be a leader for the remainder of 2024. This is an area that was completely out of favor for most of the last year. During 2023, the Health Care sector underperformed the rest of the market by 20%, falling from 7-year relative highs to near 10-year relative lows. This is exactly where Health Care bottomed in 2021, so why can’t it do so again?
What we really like is the bullish momentum divergence at these lows. After getting severely oversold on the initial test of those lows last November, RSI hasn’t dropped below 30 on subsequent declines. We saw the same types of momentum divergences at the 2020 and 2023 peaks and the 2021 bottom.
It’s not all good news. We’re in the midst of a weak seasonal period for Health Care stocks. They’ve lagged the rest of the S&P 500 by 0.55% on average in the month of March since 1990 and tend to lag again in April.
But remember that seasonality is a general guideline, not a prescription. Even in March, where the sector has underperformed the S&P 500 most consistently, Health Care has still won out a third of the time. This year could easily be the ‘one’ in the one-in-three.
The small cap sector will offer a good clue on whether our thesis of Health Care outperformance is correct. While the large cap sector has been hitting new all-time highs, the small cap space has been trying to reverse a downtrend.
PSCH has broken the downtrend line from the highs and is above its 200-day, both important steps in the reversal process, but we need to see it move past this resistance area from the 2022 lows. If we’re breaking down below this area, we need to rethink our bullish Health Care thesis.
For the large cap sector, we continue to target $155 for XLV, which is both the 261.8% retracement from the 2020 decline and the 161.8% retracement from the 2021-2023 range.
Digging Deeper
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