The U.S. equity market declined by about 5% in late summer and early fall before recovering and making new highs. The broader U.S. indices, S&P 500, Dow Jones Industrial Average, NASDAQ Composite, NYSE Composite, and Wilshire 5000 Total Market Index, made all-time closing and intraday highs in October. The small-caps, Russell 2000 and Dow Jones Transportation Average, also rising in October, did not reach new all-time highs along with other major indices. They reached all-time highs on the second trading of November.

A closer look at the resurgence of stocks reveals that the leadership has changed, which is expected following a correction and when the economic cycle progresses. It is time to conduct the relative strength analysis of sectors to figure out the leading and lagging ones.

Transports Are Leading The Market

Fig. 1: The Major US Indices – Relative Strengths

S&P 500 is doing better than the Dow Jones Industrial Average (DJIA) and the S&P 600 Small Cap Index. It is doing as well as NASDAQ Composite but underperforming the Dow Jones Transportation Average.

S&P 500 ($SPX) has been leading the DJIA ($INDU) since March 2019 (see the First Panel, Fig. 1). The pace of outperformance briefly slowed down in Q4 2020 before picking up again in Q2 2021.

S&P 500 underperformed NASDAQ Composite ($COMPQ) from September 2019 to February 2021 (see the Second Panel, Fig. 1). The broader market index then led the teach-heavy index until June 2021. Since then, the two indices have been on par with each other.

The large-cap S&P 500 is also outperforming S&P 600 Small Cap Index ($SML). From late September 2020 to March 2021, the small-caps led the large-caps. Since then, $SML has been mostly underperforming $SPX (see the Third Panel, Fig. 1).

Dow Jones Transportation Average ($TRAN)) is leading the market. It has been leading $SPX since mid-September (see the Fourth Panel, Fig. 1). Transports led S&P 500 from March 2020 to March 2021 but lagged for most Q2 and Q3 of 2021.

Defensive Sectors Are On Defense

Fig. 2: R.S. – Consumer Staples, Utilities, Healthcare, and Communications

The defensive sectors – Utilities, Consumer Staples, Healthcare, and Telecommunications – usually perform better than other sectors in a recessionary environment but not so when the economy starts to improve or heats up. Demand for the services of these sectors remains relatively stable even in a recession – falling interest rates enhance the bottom-line of capital-intensive sectors like Utilities, many Healthcare services are non-discretionary, and people need food and shelter even in a recession. However, when the economy improves, the demand for other sectors increases faster than the demand of the defensive sectors, and, hence, they underperform.

A slew of economic reports in the past few months indicate that the U.S. economy continues to improve following the slump due to the Coronavirus pandemic. No wonder the defensive sectors are underperforming the broader market. They are still rising, albeit slower than the overall market.

The Utilities Select Sector SPDR ($XLU) has been underperforming the S&P 500 SPDR ($SPY) since late October 2020 (see the First Panel, Fig. 2). $XLU had beaten $SPY in the early months of the pandemic when the economy was almost closed.

Like all other sectors, the Healthcare Select Sector SPDR ($XLV) also plunged in the early days of the pandemic before starting its uptrend in March 2020. $XLV has been underperforming $SPY since March 2020 except for a brief period from April to August 2021 (see the Second Panel, Fig. 2).

The Consumer Staples Select Sector ($XLP) is also underperforming the broader market ETF since March 2020 (see the Third Panel, Fig. 2).

The trajectory of the Communication Services Select Sector SPDR ($XLC) is slightly different. It kept pace with $SPY in 2020, vastly outperformed in Q1 2021, and then topped somewhat in Q2 and Q3 2021. Since September 2021, the ratio of $XLC to $SPY or their relative strength has declined sharply, which means that the Communications sector is weaker (see the Fourth Panel, Fig. 2).

Consumer Discretionary and Financials Doing Better

Fig. 3: Consumer Discretionary, Realt Estate, and Financials

Investors often turn up to REITs as insurance against bear markets. REITs give high dividend yields, have a slow correlation with the stock market, and typically provide a negative correlation with technology stocks. All of these characteristics become appealing when the bull market winds down, and the bear market starts. REITs lose favor when the bear market symptom recede. Real Estate Select Sector SPDR ($XLRE) did better than the S&P 500 from January 2021 to August 2021 after lagging in 2020 (see the First Panel, Fig. 3). Since September, XLRE is again underperforming the broader market ETF.

Compared to XRLE, Consumer Discretionary Select Sector SPDR ($XLY) is dancing to an opposing tune. It underperformed S&P 500 from January to August 2021 and has been outperforming since then (see the Second Panel, Fig. 3). XLY now leading is not surprising as ‘discretionary’ in the sector’s name indicates that it will do better when the economy grows.

Financials Select Sector SPDR ($XLF) fared worse than S&P 500 only briefly – from June to August 2021. Since mid-July, $XLF is again leading $SPY (see the Third Panel, Fig. 3).

Industrial, Materials, and Energy Are Straggling

Fig. 4: Materials, Industrials, and Energy

Materials Select Sector SPDR ($XLB) and Industrial Select Sector SPDR ($XLI) are meandering along compared to S&P 500.

$XLB outperformed $SPY from March 2020 to May 2021. It then underperformed the broader market ETF for a few months. Fort the past few weeks, their performance has been on par with each other (see the First Panel, Fig. 4). $XLI’s performance is almost similar to $XLB (see the Second Panel, Fig. 4).

For many years, Energy Select Sector SPDR ($XLE) was one of the very unloved ETFs. It had been underperforming S&P 500 since 2011. That changed in Q3 of 2020 when $XLE started to lead the broader market (see the Third Panel, Fig. 4). During Q2 and Q3 of 2021, $XLE and $SPY exchanged leadership, but $XLE has been mostly outperforming $SPY since mid-August.

Technology and Transports Shine

Fig. 5: Technology, Software, and Transports

Over the past many years, Technology Select Sector SPDR ($XLK) has outperformed the broader market for extended periods many times. $XLK outperformed $SPY from November 2018 to August 2020. Then for many months, $XLK mostly kept pace with $SPY before losing ground from February to May 2021. From May to August 2021, $XLK again led the market, but since then, it has been just staying abreast (see the First Panel, Fig. 5).

Software & Services ETF ($XSW) and $SPY have been exchanging the lead with each other since May 2021, though $XSW has been doing marginally better (see the Second Panel, Fig. 5).

S&P Transportation ETF ($XTN) outperformed $SPY from May 2020 to March 2021 before underperforming until July. Since then, it is again beating the broader market (see the Fifth Panel, Fig. 5).

In Conclusion

The current bull market, which started in March 2020, is beginning another leg up, but the market leadership has changed slightly. The discretionary sectors are now doing better than the defensive sectors. Small caps and transports are getting to the market leadership position. It behooves to change the portfolio mix, and it is time to get overweight on the leading sectors and underweight on the lagging sectors.