Although markets have already rallied strongly in 2012, the move is still early if current price ratio trends behave similarly to recent history. The chart shows the price ratio of the SPDR S&P Dividend Index ETF (SDY) relative to the S&P 500 (SPY). A rising price ratio means dividend-oriented stocks are outperforming (risk-off), while a downtrend suggests the opposite (risk-on). Much like a pendulum that swings from fear to hope, investor sentiment goes through cycles in terms of what type of returns are preferred at any moment in time.
Notice the far right of the chart. When we last put the post up on January 10th, the rally was just getting started, and dividend-oriented sectors such as Utilities (XLU), Healthcare (XLV), and Consumer Staples (XLP) started underperforming in a meaninful way. The persistance in the downtrend could result in further weakness in dividend stocks and strength in more cyclical/capital appreciation sectors. The estimated underperformance in SDY relative to SPY should the ratio return back to its support range is a bit under 5% on a spread trade basis. Either way, the point is that a downtrend in SDY/SPY is the bull investor’s friend, and there is likely much more room to fall in terms of the movement away from income and into growth. I discussed this idea at length in an interview I did on Bloomberg Radio last week (here)
The contrarian trade is no longer about markets going up or down, but about the length of time the trend persists.
Michael A. Gayed, CFA is Chief Investment Strategist at Pension Partners, where he structures portfolios. Prior to this role, Michael served as a Portfolio Manager for a large international investment group, trading long/short investment ideas in an effort to capture excess returns. In 2007, he launched his own long/short hedge fund, using various trading strategies focused on taking advantage of stock market anomalies. Michael earned his B.S. from New York University, and is a CFA Charterholder.