The One Constant is Change

Creative destruction is the hallmark of progress. We can think of it as economic innovation. There is actually an entire page on Wikipedia devoted to it. You can check it out here. According to the site, it is a concept in economics which since the 1950s has become most readily identified with the Austrian-born economist Joseph Schumpeter[1] who derived it from the work of Karl Marx and popularized it as a theory of economic innovation and the business cycle.

That has me thinking about what this could mean for certain investment ideas beyond the traditional equity indexes. Drilling down to the sector level of the market, it may become easy to dismiss a certain area of the market based on old norms or by looking at the sector in the traditional sense as opposed to what is potentially new and exciting. Back in June I wrote about the concept of innovation as an asset class in and of itself. This week I am going to take that concept one step further by looking at two areas of the market that may be easy to dismiss in their current form but where the new paradigm should not be ignored. 

The first is the financial sector of the equity market. When you hear “financial sector” if you are like me, the first thing that probably comes to mind is banks. But the financial sector is much larger than just the banks. There are consumer credit companies, there are insurance companies. There are also companies that cater to the capital markets industry. However, taken as a whole, the group does not look all that compelling. Despite a rally in the equity market from the March 23rd lows that has seen the Nasdaq go on to make new highs and has left the S&P 500 in a good position to the do the same, the financial sector (XLF) is still more than 20% away from the highs that were achieve in early 2020. Additionally, the group has been lagging the market since the start of the year as we can see in the chart below. 

Take this same approach when looking at the bank stocks, and we can see that the situation is similar. The SPDR S&P Bank ETF has been underperforming SPY for the majority of the past 12 months. Additionally, if we look at the Chaikin Power Gauge Ratings of the individual stocks that are holdings in the fund, we can see that 31 of them sport a Bearish rating while only four have a Bullish rating.

Does this mean that investors should ignore the financial sector of the market when they are building a portfolio or looking for new ideas. I would argue that the answer is yes…and no! Perhaps the concept of creative destruction is playing out in the sector and the old guard is being replaced by a new breed of company that is better able to serve the needs of customers in the present moment?  One area where this may be the case is in what has become known as FinTech or Financial Technology. 

According to the team at ARK Invest, a company is deemed to be engaged in the theme of Fintech innovation if (i) it derives a significant portion of its revenue or market value from the theme of Fintech innovation, or (ii) it has stated its primary business to be in products and services focused on the theme of Fintech innovation. 

In fact, they have an entire fund dedicated to the theme, the ARK FinTech Innovation ETF (ARKF), which has a Very Bullish ETF Power Gauge Rating. Unlike KBE, this fund has been leading the SPY for the better part of the past 12 months. The Adviser defines “Fintech innovation” as the introduction of a technologically enabled new product or service that potentially changes the way the financial sector works, which ARK believes includes but is not limited to the following business platforms:

  • Transaction Innovations
  • Blockchain Technology
  • Risk Transformation
  • Frictionless Funding Platforms
  • Customer Facing Platforms
  • New Intermediaries 

It probably does not make sense to dismiss the financial sector but it does make sense to broaden our view of what makes it up.

The same goes for the energy sector. There is no denying that the group has had its share of trouble of late. Taking a longer view, we can see that the Energy Select Sector SPDR Fund (XLE) has been mostly lagging SPY since the early days of 2017. The fund has a bearish ETF rating and, at the stock level, only one of its holdings has a Bullish rating in our Power Gauge model. 

However, the same question applies here. Should we dismiss energy altogether or would we be better served to alter our view of what constitutes an energy company? I would argue for the latter if the creative destruction theme is playing out here as well. 

Take a look at the Invesco Solar ETF (TAN) which has a Very Bullish rating and is on the verge of trading to a new 52-week high. At the same time, TAN is seeing an increase in the intensity of its outperformance relative to SPY.

The world is evolving and so are the investment opportunities available to us. Taking a broader view of the market, beyond what we have “traditionally” known, can put us in a position to take advantage of these opportunities as they play out over the years and possibly decades ahead. 

Dan Russo is the Chief Market Strategist at Chaikin Analytics where he writes the Daily Market Insights newsletter and provides thematic trading and investment ideas for clients. Dan is a Chartered Market Technician (CMT) and a member of the CMT Association. He holds an MBA in finance with an international designation from Fordham University.

Follow Dan on Twitter @DanRusso_CMT

  
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