What's the Market Message from Stocks in Defensive Sectors?

In recent notes, I've shared two risk-off methodologies I use to manage portfolio risk. I want to highlight another measure in today's post. The process identifies instances when traditionally defensive sector members outperform the broad market as the S&P 500 Index hovers near highs.

Defensive Sector Composite Indicator

The Defensive sector composite utilizes the percentage of members outperforming the S&P 500 Index on a rolling 21-day basis across four groups. 

The composite includes the following:

• Percentage of Consumer Staple Members Outperforming the S&P 500 Index 
• Percentage of Health Care Members Outperforming the S&P 500 Index 
• Percentage of Utility Members Outperforming the S&P 500 Index 
• Percentage of S&P 500 Members Outperforming the S&P 500 Index 

I calculate the composite by measuring the difference between each sector series and the S&P 500 series. I then count the number of groups with a spread above a user-defined threshold. The threshold for this model is plus two or above. 

Defensive Sector Composite Signal

The Defensive sector composite risk-off signal seeks to identify the following conditions.

1. The composite crosses above 2.99. i.e., defensive sector members are outperforming the broad market.
2. If condition one, start days since true count.
3. If days since condition one count is <= 15 and the S&P 500 Index crosses below the price range rank of 87%, and the S&P 500 Index is down less than 2% from a 252-day high, signal risk-off.
4. The signal resets on a cross below 0.99. i.e., a new signal can't occur until the reset condition is true.
   
   Note: The range rank for the S&P 500 uses a 63-day lookback period. 

Current Chart and Historical Signals 

The composite count remains below the threshold signal level. With the S&P 500 down greater than 2% from the most recent high, it's unlikely that a signal would trigger if the S&P 500 Index continues to correct from current levels.

Signal Performance

As one can see in the table below, performance is fairly weak in the 1-4 week timeframe.

Conclusion: Investors have not embraced a defensive risk-off mode as measured by the composite model count. If and when a signal occurs, I want to see several other risk-off models trigger around the same time. By utilizing a weight-of-the-evidence approach, one can avoid the pitfalls associated with individual signal failures.