We are also seeing a widespread accumulation in utilities stocks and distribution in the consumer discretionary sector. The miss in Amazon.com (AMZN) earnings this week highlights a crack in the bias towards consumer spending and high-beta stocks as we start the New Year. If you look at the correlation between the Utilities Select Sector SPDR (XLU) and the Consumer Discretionary Select Sector SPDR (XLY), you can see a similar trend developing as we are seeing in Treasuries.
Utility stocks are often driven higher as interest rates fall and investors grow cautious about economic growth prospects. They are often seen as an additional safety trade because of their low volatility and strong yields which make them attractive in a sell off.
Other areas of strength in January include REITs and preferred stocks which were heavily beaten down in 2013. The iShares U.S. Preferred Stock ETF (PFF) and iShares U.S. Real Estate ETF (IYR) have both outperformed this month on the back of falling interest rates and investor demand for value income opportunities. I highlighted these areas at the beginning of the year as ETF income alternatives for a portion of your portfolio. I believe that these sectors offer a unique strategy for diversification and will continue to perform well if interest rates remain accommodative.
My initial reaction to this change in tenor for equities is to keep things in perspective. The majority of stocks are still well above their 200-day moving averages and the selling pressure has been orderly. We are not seeing any significant signs of distress in the markets other than the normal ebb and flow of equity prices. That should be viewed as a positive sign that the market is digesting earnings and other macro-economic data in a typical fashion.
I have been seeing widespread use of the term "stock correction" of late, which I think is a little premature. Remember that a true correction is defined as a drop of 10% or greater. A bear market is widely viewed as a drop of 20% or greater. Therefore it is still early to call this pullback a correction when we are approximately 5% from the highs.
How you react to this data is largely a function of where you sit. If you have a large cash position and want to get more exposure to stocks, this represents an excellent opportunity to start adding to core holdings or select areas that you feel will outperform. Conversely, if you are overexposed to high beta areas of the market, you may want to look at rebalancing your portfolio to cash or fixed-income.
I am using this pullback to add to select tactical opportunities for clients in low volatility ETFs and making sure that I am balancing risk with reward. My outlook for stocks will likely change to cautious if we get closer to the 200-day moving average. That is a key risk management metric for our portfolios as we manage our way through a new wave of price data. Remember to stay balanced and nimble this year as new opportunities and risks develop.
At the time of publication the author had a position in PFF and IYR.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.