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Market driven by ‘safe’ stocks, possibly signaling slowdown ahead

We may still be in a bull market, but it really doesn't feel like one. And at least one indicator suggests we could be heading for a slide.

Since the beginning of this year, the S&P 500 is being driven by sectors traditionally considered to be safe investments, such as utilities, telecom and consumer staples. The stock index was hovering less than a percent off its own 52-week high as of Friday morning.

Generally, when the broader market is lifted by these "defensive" sectors, it means investors are looking for safe havens where they can weather a future storm. That could be a precursor to an economic slowdown.

In fact, one of the last times we saw defensive sectors outperform riskier ones was in 2007, just before the onset of the financial crisis.

Simply put, professional investors rotate their investments from risky, high-flying sectors such as technology and consumer discretionary — also known as the "cyclical sectors" — into safer sectors when they're less optimistic about the economy.

The Dow and S&P 500 both hit all-time highs in May 2015, and the Nasdaq did so in July of the same year.

Shifting strategies

One reason we're seeing so much sector rotation this year is a shift in investment strategy. Momentum strategies that favored volatile tech stocks paid off handsomely last year.

But that same strategy has seen a reversal in 2016, with money flowing out of those risky bets and into stocks such as utilities. Investors are also looking to shares that are trading the furthest away from their 52-week highs, such as in the energy and materials sectors.

Those two strategies have proved to be standout performers of the current market, according to an analyst at research firm Markit.

"High-flying Facebook, Amazon, Netflix and Google shares, or 'FANGs', were hotly tipped at the start of the year, but the recent market volatility has seen average returns delivered by these mercurial shares lag behind the rest of the market," analyst Simon Colvin of Markit wrote in a May 20 blogpost.

Indeed, companies in the S&P 500's energy sector, which sold off 23 percent last year, have bounced back by more than 12 percent so far in 2016, as of Friday morning. Similarly, utilities, which were off by more than 8 percent last year, comprise one of the best-performing sectors, gaining more than 20 percent year to date. Materials too, which were down more than 10 percent last year, are up more than 6 percent in the last few months.

That compares with the tech sector, which was up almost 5 percent in 2015 but remains down 1 percent since December.

That poor showing isn't limited to technology stocks. The more volatile half of U.S. large-cap companies (as measured by Markit's Signal 60 Month Beta factor) have lagged behind their less volatile peers since the beginning of the year, Colvin wrote.