This Is What Sector Rotation Looks Like

 | Jun 15, 2017 | 2:00 PM EDT
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Faithful readers of my column will know I am a bit of a market historian. The market action of the past two weeks has me scratching my head and looking for historical parallels. 

The first thing any market watcher looks for is divergence. I have noted that for the past two weeks the Nasdaq has tended to underperform the DJIA, and that is exactly what is happening today. The smart money seems to be exiting "big tech" and going toward bank stocks and some consumer staples, hence the DJIA's recent outperformance vs. the Nasdaq after badly lagging since the election. 

Faithful readers will also know I spent 11 years as a Wall Street analyst following the automotive and auto parts sectors. More than anything, that experience taught me how to recognize sector rotation. When autos go out of favor, an auto analyst can feel like the Maytag repairman. I have often noted that "my phone stopped ringing," and while that is an exaggeration, it is only a slight one. 

The great thing about sell-side research is the "sell" part. Individual investors may not know this, but every investment bank has a cadre of salespeople whose only job is to market analyst research -- they also market stock offerings, but the two are inextricably linked. So to have one of these salespeople walk into one's office and say "XXX portfolio manager at XXX mutual fund complex doesn't care about your sector, so stop calling him/her" is a terribly informative -- and humbling -- experience. 

Fund managers are rotating out of tech. It's happening, and while that doesn't mean analysts following Apple (AAPL) and Amazon (AMZN) are no longer having their calls returned by fund managers, it is palpable when analyzing the tape. The herd mentality around the FANG stocks is something I have seen before. But herds tend to reverse direction quickly, and as an individual investor, you can't possibly have large enough positions to affect these price moves. 

Retail investors are price-takers. There are no two ways about that. If you think Fidelity's fund managers are "lightening up" on Facebook (FB) and Google (GOOGL) and "moving to an overweight position" on JPMorgan (JPM) and Johnson & Johnson (JNJ) , then it would behoove you to follow their lead. 

That's what I'm looking for this summer. Not an absolute "tech wreck," but a largely orderly rotation out of a group that is extremely overvalued by any historical measure. Those fund managers, however, seem to be rotating from one sector to another in an asset class itself -- U.S. stocks -- that is also overvalued by historical measures. The S&P 500 is trading at a 12½-year high in terms of forward P/E multiple. Banks are not cheap based on book value multiples, and consumer staples aren't cheap based on forward P/E's, either. 

Again, I am putting my clients in fixed-income securities. I do not manage enough assets to compete with Fidelity, but I know that other fund behemoths like Vanguard and BlackRock are dominated by passive investors. They buy the stocks that are doing well with very little regard to valuation, and that strategy is not risk-free. 

I'll have a new Real Money Best Idea in tomorrow's column. It's a preferred stock, just like my current Best Idea, Navios Maritime's Preferred Series G (NM-G) . As you can see on the side of this page, NM-G has more than quadrupled since I started buying it in January 2016. That is the type of asymmetric return that can be produced by buying a distressed security. 

It is a risky strategy, to be sure, but is it really any riskier than standing by and passively watching as a herd of cow-like fund managers stampedes in the opposite direction? I don't think it is, and I look forward to sharing my idea with you tomorrow.

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