Conclusion, Investment Implications, Strategy

With six weeks left in 2024, and despite nervous, frenetic sector rotation for most this year due at least in part to the Presidential Election, our SEAF (Sector ETF Asset Flows) Model has stayed right with the S&P 500 (SPX) for most of this year but with a 30% lower drawdown.  Bigger picture, since inception in June 2018, SEAF has outperformed SPX by more than 8% on an annualized basis and with a lower maximum drawdown and a significantly higher Sharpe Ratio.  Moreover, SEAF has been outperforming its peers — ETFs that do some form of sector rotation — for most of this year and has outperformed them on an annualized basis since inception.

Introduction

Sector rotation has faced an intriguing and turbulent year, characterized by heightened sector churning. The unusual tandem of XLU (Utilities) and XLK (Technology) has drawn attention, fueled by the AI (Artificial Intelligence) boom that has reshaped market dynamics. Companies have rapidly rebranded as “AI” firms, sparking a surge in demand for increased power capacity and infrastructure to support this technological shift. Add to that interest rate cuts and a highly charged election cycle, and it’s clear why capital hasn’t stayed anchored in any single sector for a significant period.

2024 US Broad Market Performance

Year to date, only two sectors—XLF (Financials) and XLC (Communication Services)—have outperformed the S&P 500 (SPX), and even these have lacked consistent strength throughout the year. Currently, the S&P 500 boasts a trailing 12-month gain of 35.9%. It’s important to note, however, that over the past five years, the S&P has averaged a more measured annual return of 14.2%. This blend of a scorching-hot market and the absence of a dominant sector leader has posed considerable challenges for traditional sector rotation strategies.

2024 SEAF Performance

Despite these headwinds, SEAF has demonstrated impressive resilience and competitive performance. Over the trailing 12 months, SEAF has returned 34.8%, 1.1% less than SPX but with a maximum drawdown roughly 30% less than the benchmark index.  Moreover, since its first full year in 2019, SEAF’s top-performing sector has consistently aligned with the best-performing sector among the 11 Select Sector SPDRs, underscoring its ability to identify and capitalize on sector momentum.

SEAF’s success lies in its ability to closely track the acceleration and deceleration of asset flows in multiple time frames and and to position itself according to those data. When capital accelerates into specific sectors, SEAF adjusts to follow the money, ensuring that investors are positioned in sectors that show the best characteristics for relative outperformance.  As the data shows, this dynamic approach is crucial to staying ahead of the next trend and seizing opportunities in an ever-changing market landscape.

SEAF Model Performance

The green line in Chart 1 below plots the SEAF’s Model’s trailing twelve-month daily performance, with the corresponding performance of the S&P 500 plotted by the blue line.  The chart shows that, although the SEAF Model fell behind between May and August, it has since caught up to SPX  heading into the end of the year.

Chart 1

The green line in Chart 2 below plots the SEAF’s Model’s daily performance since inception in June 2018, with the corresponding performance of the S&P 500 plotted by the blue line.  

Chart 2

The green highlights in Table 1 below show the details: the SEAF Model outperformed the S&P 500 in every category listed during this period, including outperforming the broad market index by more than 8% on an annualized basis and with a lower maximum drawdown and a significantly higher Sharpe Ratio.  Moreover, SEAF has been outperforming its (four) peers — ETFs that do some form of sector rotation — for most of this year and has outperformed them on an annualized basis since 2020. 

Table 1

So, don’t get distracted by the near-term noise as the money hops from sector to sector, trying to catch the next “sticky” outperformance trend, but rather focus on the big picture.  The power and the advantages of data-driven investing are not getting knocked off of your long-term game by short-term market conditions.