Rising market volatility tends to lead to changes under the surface of markets, even if the headline index performance remains fairly range-bound. This is especially true today, as volatility has been steadily rising since the beginning of the year, and market leadership continues to shift. Much of the prior year’s leadership has sold off, while defensive and real-asset correlated sectors have taken off. There has been nearly a 50% dispersion between the top and bottom sectors in just 6 months, yet the overall market has only modestly fallen (and diversified investors are likely seeing positive returns). This leadership change is likely best reflected in value and growth, with value-oriented sectors broadly outperforming growth-oriented sectors.
One way to sift through these changes, as I have written about before, is to look at the combination of price and fundamental valuation shifts. We know valuations are not good timing tools – within sectors, we use relative momentum for that – but valuations can inform the degree to which a sector is being fairly or unfairly priced. Put another way, we can gain insight into where investors are over- or underreacting.
Stay on Top of Market Trends
The Carson Investment Research newsletter offers up-to-date market news, analysis and insights. Subscribe today!
"*" indicates required fields
The immediate standout here is the change in industrial valuations. This is due to a large increase in price performance (especially through the month-end, as measured in the relative valuation chart) without a subsequent increase in earnings, sales, or cash flow. Of course, the market is pricing in the anticipation of those increases – industrials have a large weight in aerospace and defense companies – but analysts aren’t forecasting the same. More on that in a bit. Otherwise, the traditional growth sectors still appear a bit rich relative to where they normally trade, and the more defensive sectors are showing some value still. Financials and health care stand out as sectors that were undervalued a year ago (light blue) but have gotten even cheaper since then, despite some positive price movement. These are areas we are watching closely.
Market worries have not hit earnings expectations, which is particularly important. Projected growth for large caps next year is still in the mid-double digits, with many sectors at or near the double-digit level. These are very strong expectations, and as we know with Wall Street, expectations are generally set and steered at levels management teams believe they can beat.
Sector investing can be an important tool and also a source of information about market sentiment and strength. We invest in sectors in specific tactical ways to add value for clients, and measure and monitor sector performance on a daily basis to help determine what the market “is thinking” rather than what others are saying.
For more content by Grant Engelbart, VP, Investment Strategist, click here.
8838825.1. – 24MAR26A
