“It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of light, it was the season of darkness, it was the spring of hope, it was the winter of despair.” ― Charles Dickens, A Tale of Two Cities

It was the worst of times (Start of the year through February 11). It was the best of times (February 11 through today).

It’s been a tale of two markets thus far in 2016. After the worst start to a year in history for the S&P 500, we have seen one of the most dramatic reversals of all time.

On February 11, the S&P 500 was down over 10% on the year and all hope seemed lost. Global recession, deflation, and bear market were the hottest buzz words of the day.

The fear and loathing on February 11 would mark the bottom, and since then the silver linings playbook has taken hold. The S&P 500 (total return) reached a new all-time high last week, and those predicting calamity and recession just two months ago are nowhere to be found.

The disparity in market behavior before and after February 11 is most easily observed in viewing sector performance.

To start the year, leadership was most prominent in the lower beta, defensive Utilities and Consumer Staples sectors. Incredibly, even with the broad market down over 10% on February 11, Utilities were up over 5% on the year. Contrast that behavior with the worst performing sectors at the time, Financials (-17.5%) and Consumer Discretionary (-12.3%).

Since February 11, Utilities and Consumer Staples have been the worst performing sectors and we’ve seen leadership in the higher beta, cyclical sectors. Energy and Materials have seen the most strength, with Crude Oil rallying nearly 70% off its February low (ending the longest downtrend in its history).

Beta Rotation and the Signaling Power of Utilities

While these risk-on/risk-off moves seem arbitrary and impossible to make sense of, our research on Beta Rotation continues to be instructive (click here to download).

The cliff notes version of our paper:

When Utilities are leading the market, you tend to see higher volatility (on average, there is no holy grail) and an environment more favorable for defense. When Utilities are underperforming, you tend to see lower volatility (on average, there is no holy grail) and an environment more favorable for offense.

Using the signal outlined in the paper, our Beta Rotation Index (Ticker: BETAEQ) goes back to 1989, rotating between defense (Utilities, Consumer Staples, and Health Care) and offense (S&P 500).

The Beta Rotation Index was defensive to start the year, protecting capital and minimizing volatility during the sharp declines in January and February. It is currently in offensive mode, suggesting an environment that has been more favorable to higher beta in the past.

Click here to download the latest fact sheet for the Beta Rotation Index.

As for the market, the full tale of 2016 has yet to be told. The odds favor at least one more risk-off period (the average year has 3-4 corrections greater than 5% in the S&P 500) where defense will be critical, but for now the weight of the evidence still favors offense.

The biggest takeaway from the wild action to start the year: try to understand the case for both sides (bullish and bearish) and have a systematic plan/process to deal with periods of higher volatility. Only then can you be flexible and intellectually honest enough to change your mind as the facts and conditions inevitably change.