The S&P 500 Suck at Defense

SPDR Sectors - The Construction of the S&P 500

As a market-cap weighted index, the S&P 500 ($SPY) is not designed to fully reflect the overall story of the stock market. The good news is with some simple sector analysis, the picture becomes much clearer.

A simple yet effective tool to gain more clarity is using the eleven SPDR sectors to gauge what’s really happening beneath the surface. The eleven sector SPDRs represent the S&P 500 as a whole. You can see the classifications below.

Sector Rotation Analysis - Offense vs. Defense

We can analyze these sectors by viewing them as either offensive or defensive. You can see in the graph below, the stock market (orange line) is a leading indicator for the economy (blue line). Offensive sectors will be on the field as economic growth begins but as positioning shifts from offensive to defensive sectors it can be indicative of future economic slowdown. It doesn’t take rocket science to understand that it’s easier to score points when offense is on the field versus defense.

In terms of the 11 sectors, Technology ($XLK), Consumer Discretionary ($XLY), and Communication Services ($XLC) can be viewed as offensive sectors, while Real Estate ($XLRE), Utilities ($XLU), and Consumer Staples ($XLP) can be viewed as more defensive. It’s not an exact science, which is why I’ve only labeled the least nuanced sectors as offensive and defensive.

S&P 500 Sector Weightings - What Steers The Ship?

Over time the S&P 500 has grown into a very offensively positioned index with little exposure to the defensive areas of the market. Not only are there economic implications of sector rotation, but also a very real underexposure issue when defense if on the field. This is critical to understand because, in times of economic uncertainty or slowdown, the S&P 500 offers little protection.

How are you positioned when Defense is on the Field?

Up until July, offense was on the field. The two best performing sectors year-to-date (YTD) were Technology ($XLK) and Communication Services ($XLC). The S&P 500 was humming along with a YTD return of around 14% through June.

Since the start of July, we've seen a turnover by the offense and a struggle to regain possession. Real Estate ($XLRE), Utilities ($XLU), and Consumer Staples ($XLP) have taken the field, while Technology ($XLK) and Communication Services ($XLC) are left on the bench. Many implications can be drawn from this, whether it's the market being due for a pullback, a healthy rotation, or even mean reversion. However, the implications can conform to whatever bias we want to portray through the market. What matters is what is happening and how investors are positioned for it.

Admittance is Step 1

While the S&P 500 is the most popular “stock market” index in the world, it can be misleading on the surface regarding what is actually taking place in the market. Sector analysis allows us to peel back the onion and see who is scoring the points and what positioning the S&P 500 has us in, so we can adjust accordingly. No one knows what’s next, but until we see the offense back on the field, it’s going to be hard for the S&P 500 to score points.

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