Sector Roatation

In the year 2000 the S&P 500 traded at well over forty times earnings. A decade later the S&P 500 is still significantly lower. Valuation is the largest determinant of long term returns but matters very little in the short run. Sector returns are also dependent on valuation in the long run but in the short run many other factors come into play.

A year ago everyone shunned retail and real estate stocks as the death of the consumer and real estate were widely heralded. Since then these sectors have seen the most impressive returns. The valuations in these sectors have gotten silly but managers were underweight the sectors and are forced to chase them higher or risk falling further behind their benchmark.

It has not mattered that many retailers trade at north of thirty times earnings even though we are in the midst of a secular deleveraging. It has not mattered that many REITs trade at well above NAV.  All that has mattered is that these sectors were running the hardest and most were underweight or short the group. In the long run I have little doubt that these sectors will revert back to a normal valuation.

Yesterday was the first day in a very long time that the retailers lagged the market. That might be a hint that managers have finally finished rotating into the consumer discretionary sector. I will keep an eye on the sector in the coming days to see if it continues to lag. If the market bounces and the bounce in retail is lethargic, they might make for a good short.

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