Sitting atop the sector leaderboard in 2023 is Communication Services. Just like most of the equity market during September, Communication stocks have faltered. But they’ve dropped somewhat less than most of the market over that period, putting their year-to-date gain at 36.9%. That’s more than triple the benchmark’s 11.8% rise for the year.
The Communication Services sector has made us wary for quite some time now.
The primary source of our concern has been the weakness below the surface. Even though the sector has been a huge outperformer all year – its 39% gain lags only the 42% rise for Information Technology – most stocks in the sector just aren’t doing that well.
Check out the equally weighted Communication Services ETF vs. the equally weighted S&P 500: you’ll find a ratio that’s meandering sideways after a steep, extended downdraft. This is not what internal relative strength looks like.
If you want to outperform the market, you need to own the things that are outperforming the market.
It’s not enough to just make money during a bull market. You could own Treasurys and “make money”, but there’s a huge opportunity cost of owning Treasurys when you could own stocks that are rising in value much faster.
That’s why we spend so much time looking at relative charts. We want to know which sectors and stocks are leading and lagging so we have a chance of finding the ones that will beat the benchmark.
And on a relative basis, the Communication Services sector has a problem with overhead supply.
The Communication Services sector went from being the worst sector in 2022 to one of the best in 2023. Now it’s beginning to fall back out of favor.
Relative to its benchmark, the S&P 500 index, the sector made it all the way back up to its mid-2018 lows. That’s also where its underperformance accelerated last spring and where it was rejected on a summer rally. That area is acting as resistance once again.
It’s been a good run for the sector.
There are two ways to work off a momentum divergence. Through corrective price action or through time.
A bullish momentum divergence at the November lows helped jumpstart a bearish to bullish trend reversal in the Communication Services sector. Now we’re eyeing another momentum divergence.
Throughout most of 2022, Communication Services was one of the worst places you could put your money. But when the sector broke down to new lows in November, momentum failed to confirm the selloff, signaling a bullish divergence. Our view on momentum divergences is that they usually lead to mean reversion rallies. Those mean reversion rallies sometimes lead to trend reversals.
The Communication Services sector reversed some of its year-to date gains, causing us to wonder: Is the group set to resume its multi-year downtrend, or is this just a digestion of the rally?
For the first time in over a year, we are forced to question whether the Communication Services sector is still in a downtrend. The group has been the unquestioned laggard on the downside since September 2021, but an impressive rally to start January has them breaking through the relative downtrend line from those 2021 highs.