This Sector Could Shine in Q2

Hey Traders,

The stock market was closed for Good Friday, but hey — MONEY NEVER SLEEPS, so neither do I!

This week marked the end of March, and it was a wrap on the first quarter of 2021, too.

Unless you’ve been hiding under a rock, you likely know it was generally a strong stretch for stocks — the Dow and S&P 500 just enjoyed their best month since November, and rallied 6.6% and 4.3% in the quarter, respectively.

Tech stocks, on the other hand, underperformed, with the tech-heavy Nasdaq gaining just 0.4% in March and a relatively mild 2.8% in the first quarter.

Why does this matter?

Well, the end of the quarter is when many mutual funds and portfolio managers “window dress” their holdings, and it’s also a time when I pay particularly close attention to one exchange-traded fund (ETF) …

Window Dressing

Window dressing is when financial institutions or money managers try to “dress up” their portfolios, so their quarterly reports look better for clients and the people to whom they answer.

Think of these institutions as used car lots … 

What’s more likely to get your attention as you drive by? A newer, shiny BMW, or an old, rusty El Camino? 

If you said the El Camino, well, you might have more problems than I can fix.

The sparkling BMW is more likely to catch your eye — and, thus, lure you on to the lot — right?

It’s the same thing with these investment managers.

They’re looking to put the pretty stocks at the front of the proverbial lot, because it makes them look like wiser investors to clients, both current and prospective.

Therefore, at the end of each quarter, it’s not uncommon to hear of portfolio managers buying stocks that have been outperforming, and dumping stocks that have been underperforming.

As such, it’s not uncommon for the prevailing sector trends to be amplified at quarter’s end — sectors with upside momentum can get a little boost from window dressing, while struggling sectors can see downside momentum exacerbated by institutional dumping.

However, under this premise, we likely would’ve seen some quarter-end selling of tech stocks, and we haven’t seen much of that lately …

The Technology Select Sector SPDR Fund (Ticker: XLK), for instance, just had a solid couple of days, despite ending the quarter not far from breakeven.

Daily chart of XLK with Q1 breakeven – courtesy of StockCharts

In the same vein, energy and financial stocks — which have skyrocketed in 2021 thus far — seemed to peter out as the quarter wound down, per the Energy Select Sector SPDR Fund (Ticker: XLE) and the Financial Select Sector SPDR Fund (Ticker: XLF), respectively.

Daily chart of XLE with Q1 breakeven – courtesy of StockCharts

Daily chart of XLF with Q1 breakeven – courtesy of StockCharts

So, while window dressing can impact some stocks’ end-of-quarter performance — and, thus, should be on your radar — it’s not necessarily something we’ve seen so far in 2021.

However, neither the XLK, nor the XLE and XLF, is the ETF I’m honed in on right now — the one telling me which sector could heat up in the second quarter …

The Equal-Weighted ETF I’m Watching

That privilege belongs to the Invesco S&P 500 Equal Weight ETF (Ticker: RSP).

RSP is based on the S&P 500 Equal Weight Index, and equally weights the stocks in the S&P 500 Index (Ticker: SPX).

Why is this important?

Because the fund is rebalanced quarterly.

Per the Invesco website, “Over time, systematic rebalancing from outperforming to underperforming stocks creates a buy low/sell high discipline.” This has allowed the RSP ETF to outperform the SPX by nearly 120% on a cumulative basis since inception.

Here’s the main stock market index vs. its RSP counterpart more recently:

SPX (blue) vs. RSP (red) – courtesy of StockCharts

Despite underperforming most of that time, RSP just took back the lead in February, suggesting the most recent quarterly reset could be one to watch.

And since RSP automatically sells winners and buys losers at the turn of every quarter, in order to get back to an “equal weight” setting …

This suggests there’s a rebalancing into TECH — the beleaguered sector of Q1 2021 — which makes me think this sector could have a pretty good quarter.

We shall see …

Have a great long weekend, Traders!

Your Only Option,

Mark Sebastian

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