On the surface, June appeared to be a quiet month, however beneath the surface it was an interesting month. Let us review recent market activity including the recent sector rotation, and discuss latest economic and corporate data, writes Ketu Desai.

While the S&P ended the month with only a small gain, there was some turmoil among various sectors. A few large capitalization technology stocks, Apple, Google, Facebook, Amazon, Microsoft have generated roughly 30% of the S&P 500’s gains this year. On a Friday afternoon in early June, on limited news, and certainly no fundamental news, these stocks started a reversal. Many explanations have been offered as to why these stocks started to fall then, including a Goldman Sachs’ research note. Tech stocks fell approximately 3% on that day, and the negative sentiment remained for the remainder of the month. It appears that the selling was a combination of sector rotation and profit-taking, as we approached a quarter-end. Sector rotation is simply, investors moving capital from one sector into another.

While in the larger picture, the move is not very significant, the move does highlight the broad ownership of technology stocks across various investment styles and factors. It is not frequent where you see the same names in growth, value, equity income, momentum, and low-volatility portfolios, and that is what you were seeing with many of these names. The move also emphasizes the importance of understanding the underlying portfolio exposures and true factor diversification. For instance, a portfolio with Vanguard Growth ETF, iShares Value ETF, and Vanguard High Dividend Yield ETF – three seemingly different factors, would have over 20% in exposure to technology. The risk is when there is a sell-off in technology, a portfolio that you think is diversified, may suffer more losses than anticipated.

As the money flowed out of technology, generally, growth dollars flew to biotech, and value dollars flew to financials. Biotech and financials also benefited from news out of Washington.

The market perceived the Senate healthcare bill as positive for biotech, as well as results from the Federal Reserve stress tests on banks.

This sector rotation has generally favored value, as for the year, Russell 1000 growth has outperformed value by nearly 10%. Value stocks are ones that trade below their fundamental value, it could be cheap on an earnings basis, cash-flow, dividend, etc. Growth stocks are ones that are expected to provide high level of sales or earnings growth in the future. During the year, growth has outperformed, as the economy appears to be stuck in a 2% growth environment, investors are willing to pay for higher levels of growth, the majority of which is coming from the technology sector.

First quarter GDP got revised up again to 1.4% from a revised 1.2% and an initial 0.7%. First-quarter economic growth was boosted by an upward revision to consumer spending, which accounts for more than two-thirds of U.S. economic activity. While Q1 looks better, the reading from the Atlanta Fed on Q2 continues to move down, and now stands at 2.7%. While noisy, the direction of this series has been down, it was north of 4% earlier in the quarter. Such growth numbers suggest that high growth is valuable, and that the sell-off in technology stocks is simply a rotation, and not a commentary on their business fundamentals.

Looking forward, we will start to receive earnings reports in the coming weeks. Q2 earnings are expected to grow 6.6% with 4.9% revenue growth. It will be an exciting summer in the markets!

Interested readers can reach Ketu Desai by email ketu@isquaredwealth.com.