XLY - S&P 500: Cautionary Start For 2024 But It's Not As Bad As It Looks

2024-01-12 06:00:00 ET

Summary

• Cyclical sectors started the year on a down note, indicating concerns about a possible recession in 2024.
• Defensive sectors like healthcare and utilities are performing well, also due to concerns about a possible recession in 2024.
• The performance of key stocks suggests that some of the sector's performance is due to firm-specific issues rather than macro implications, and big tech stocks are still performing well.

Cautions start for 2024

Professional investors usually wait for the year to end before making adjustments to their portfolios or tactical positions for many reasons. For example, for tax reasons, or even to maximize their annual bonuses. That's why it is important to monitor how the year starts as that could signal how the rest of the year could develop.

This year, 2024, is particularly interesting to monitor the trading activity at the beginning of the year after the outperformance of the tech sector in 2023, given the developing monetary policy situation, the 2024 elections, and a possible recession.

So, the year started volatile. After the first six trading days, the S&P 500 ( SP500 ) ( SPY ) is slightly up by 0.29% However, the year started with selling, which was followed by the bounce.

When looking at the sector's performance, it appears that investors are playing very defensive. The market is led so far in 2024 by the health care sector ( XLV ) up by over 3%, followed by the utilities sector ( XLU ), up 1.78%, and consumer staples sector ( XLP ), up by 0.76%. These are traditionally known as the defensive sectors. Investors usually buy these defensive sectors before a recession, when the cyclical stocks drop and interest rates decrease.

Does this signal a recession in 2024? Yes, if the institutional investors are allocating to these defensive sectors at the beginning of the year, it is likely they believe that a recession is likely sometimes in 2024.

So, let's look at the performance of the traditional cyclical sectors. The consumer discretionary sector ( XLY ) is down by 1.4%. The Energy sector ( XLE ) is down by 2.73%. The Industrials sector ( XLI ) is down by 1.41%, the Materials sector is down by 2.24%. These sectors closely follow the business cycle, and thus heavily depend on economic activity. Obviously, during a recession, business investment decreases which affects the industrials, energy, and materials, while the consumers cut discretionary spending. Thus, the performance of the cyclical sector is also consistent with a recession in 2024.

What about tech? The technology sector ( XLK ) which is considered speculative, is down by 0.95%, which possibly signals some profit taking after the 50%+ performance in 2023.

What about the financials so far in 2024. The financial sector ( XLF ) benefits are the interest rate decrease and the yield curve dis-inverts and steepens. This usually happens in an early stage of a recession; thus, the financials are the leading sector in a new cycle. The financials are up by 0.56% so far in 2024.

Thus, it appears that investors are worried about a recession in 2024, the defensive sectors are up, while the defensive sectors are down - and this is only during the first six days of trading in 2024. Here is the chart:

But it's not as bad as it looks

So, definitely, we are getting a worrisome outlook from the beginning of the year's trading activity. But, let's look at the performance of some of the key stocks to get more insights.

When we look at the performance of the Discretionary sector, we see that Tesla (TSLA) down by 5.85%. Given the size of Tesla, this has a significant effect on S&P 500. It is hard to say that Tesla is down by 5%+ due to cyclical reasons, it has to do more with the shaky demand for EV, so I view this more as a firm-specific issue, rather than a systematic issue.

Further, when you look at the Industrials, Boeing ( BA ) is down by 12.59% YTD, and this has to do with the firm-specific issues, primarily the issues with the Boeing Max 9 plane. Given the market cap of Boeing and its high price, it affects significantly the price-weighted Dow Jones Industrial Average ( DJI ), as well as the overall industrial sector. Thus, I would not view the performance of Boeing as a systematic issue with recessionary implications.

Materials are also down, but led to the downside by Newmont ( NEM ), down by 8.31%, and this has to do more with the speculation in Gold and Silver, than systematic issues. Yes, we know that China is in crisis, which affects the demand for commodities, and thus the Materials sector, but this does not signal a US recession. Similarly, energy is also down, but this has to do more with speculation in crude oil given the geopolitical situation.

Yes, defensive sectors are up, but there are some key firm-specific issues that have been driving the performance of big stocks in these sectors to cloud the overall implications with respect to a recession in 2024.

What about the Magnificent 7?

The S&P 500 has been led by the Magnificent 7 in 2023, and many expected some profit taking at the beginning of 2024, given the uncertain macro environment.

The Technology sector is down, but it has been significantly affected by Apple (AAPL) down by 3.29%, which was downgraded due to firm-specific reasons, which also does not have macro implications. Tesla is in a similar situation, as previously discussed.

But Nvidia (NVDA) is up by 9.75%, extending the 2023 magic run. Microsoft (MSFT) up by 1.79%. This signals that investors are still "chasing" the AI theme, which is not consistent with a defensive risk-off behavior. Similarly, Meta (META) up 4.66%, Alphabet is up by 2.04%, and Amazon up 1.18%.

Thus, investors are still allocating to the Magnificent 7, and any possible dip is quickly bought. This has positive macro implications, and positive implications for the broader market.

Implications

Based on the sector performance during the first days of 2024, it appears that investors are concerned about a recession, given the relative performance of defensive and cyclical sectors.

However, after further looking at the performance of the key stocks, it appears that some of the performance is due to firm-specific risk, and has no macro implications. I would focus more on the positive performance of big tech, as this shows that investors still have a risk appetite. Thus, my recommendation is still a BUY for S&P 500.

This is consistent with the outlook that the Fed thinks that a recession is not necessary for inflation to return to the 2% target, and, thus, it is willing to cut interest rates.

For further details see: