This is a hard question to answer, which is why I only trade the S&P 500’s ETFs. Even in my hedge fund days, we never traded sector ETFs because we didn’t have a consistent and accurate way of predicting which sectors would outperform.
Here’s the S&P 500’s sectors in 2017.
Notice how tech clearly outperformed the index in 2017, while energy and telecom underperformed.
*Tech is the S&P 500’s largest sector while energy and telecom are small sectors.
What does this mean for tech in 2018?
Despite the Republican tax cut, I’ve already stated that small cap might not outperform tech in 2018.
Tech outperforming in 2017 doesn’t mean that tech can’t outperform in 2018 as well. In fact, there’s a 50-50 chance that tech will continue to outperform the broad index.
The NASDAQ’s 14 monthly RSI (momentum indicator) is very high right now.
Historically, the NASDAQ can continue to rally for months despite the extremely overbought monthly RSI. There’s no guarantee that tech will underperform in 2018. Here’s NASDAQ on a log scale.
Here are my discretionary thoughts on other key sectors.
Finance will underperform in the first half of 2018
The financial sector is one of the S&P’s largest sectors. It has a very strong correlation to the 2 year Treasury yield.
*This correlation exists because higher yields = higher profit margins on loans.
Here’s XLF (financial sector ETF).
Here’s the 2 year Treasury yield.
I stated that the 2 year Treasury yield is EXTREMELY OVERBOUGHT on every single time frame.
Here’s the 2 year yield and daily RSI (14).
Here’s weekly RSI.
Here’s monthly RSI.
So if the 2 Treasury yield consolidates/corrects during the first half of 2018, then that is not bullish for the finance sector. Finance will struggle if yields struggle.
The energy sector depends on oil
I don’t think the energy sector will significantly outperform the S&P 500 in the first few months of 2018.
The energy sector is highly correlated to the year-over-year change in oil $.
Here’s WTI oil.
Here’s XLE (energy sector ETF). Notice that oil tends to lead XLE by approximately 1 month.
The U.S. oil rig count is set to explode in 2018. As a result, I don’t think oil will go up significantly in the first few months of 2018. Based on the energy sector-oil correlation, I don’t expect the energy sector to outperform in the first few months of 2018.
So which sectors will outperform in 2018? It’s hard to say. Perhaps consumer discretionary will outperform as
- wage inflation finally picks up and
- the economy approaches NAIRU (full employment).
Trying to guess which sector will underperform and which sector will outperform is extremely difficult. Just stick to trading the broad index.