My view on what's going on in the financial markets and the global economy, and a few other things that might interest me from time to time.

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  • tim@emorningcoffee.com

Sector Performance Post-Market Recovery

Updated: Jul 19, 2020

On March 25th, I wrote an article on the ETF sectors, which you can find here. At the time, we were just off the U.S. equity market bottoms, although that was far from clear at the time. Since then, the market has had nine solid weeks, with the S&P 500 sitting at a touch less than 6% of the level at which it opened 2020. This has been a remarkable recovery especially in light of the circumstances and the deep global recession that the world finds itself in.

I thought it would be interesting to refresh the post on sectors to see how the performance has been year-to-date, and specifically to look at which sectors have driven the recovery. The recovery was initially driven mainly by tech, healthcare and consumer non-cyclicals, but there is increasingly talk that the rally is broadening to include many of the out-of-favour sectors, even reaching into severely troubled sectors like energy, real estate/property and travel / entertainment industries. For purposes of this analysis, I have used the same 11 SPDR sectors as in the last article.

Although I do not intend to rehash the last post, recall that there are some factors and attributes of some of the sectors that you might not necessarily find obvious. For example:

  • The Technology sector includes the likes of Microsoft, Apple, VISA, Intel, Mastercard and NVIDIA, but names like Facebook, Google, Disney and a host of gaming, cable and mobile telephone companies are in the Communications Services sector.

  • The Consumer Discretionary sector includes Amazon, the third different sector to contain one of the infamous FAANG stocks. Consumer Discretionary also includes Home Depot, Lowes, McDonalds, NIKE, Target and Starbucks, as well as hotels, retail, cruise ships, travel companies (e.g. bookings.com and Expedia), gaming companies and restaurants, all troubled industries.

  • Several other beleaguered industries like airlines, railroads, aerospace and marine and transportation generally are in the Industrial sector.

  • Even though Target and the home improvement companies are in the Consumer Discretionary sector, Walmart – along with P&G, Pepsi and Coca-Cola – are in the Consumer Staples sector.

  • The Healthcare sector top holdings are dominated by pharma and biotech companies, not hospitals / hospital management companies.

  • The Energy sector’s top four holdings, accounting for over 53% of the holdings, are Chevron, ExxonMobile, Phillips 66 and ConocoPhillips, with the remainder of the holdings – a minority - including energy services companies and the under-pressure independents / fracking companies.

This list of interesting facts goes on, and I wanted to point it out first so that when looking at performance, you are aware of some of the unusual “quirks” of the SDPR index funds that might not be obvious on the surface. You can look more deeply into these on State Street Global Advisors’ ETF website, which provides a lot of information on each sector including all of their holdings.

Sector Fund Attributes

The tables below provide an update on the key attributes of the 11 SPDR sector funds, as well as the S&P 500 SPDR ETF (SPY). All of the data is either from Yahoo Finance or directly from the State Street website.

You can go back and compare this to the original table in the March 25th article, but in general as you would expect, AUM and the price ratios (to-earnings, book value and sales) have increased significantly, and the dividend yields have fallen. None of this is really surprising given the overall rally, but what is perhaps more interesting is to look at the relative performance of the sector funds.

Performance of Sector Funds

The table below illustrates the performance of each sector fund over five time frames which I consider relevant:

  • Since inception of the fund (mostly 1998)

  • Since the end of 2006, because 2007 is when the Great Recession began

  • Over the last 10 years, capturing much of the bull run prior to the pandemic

  • YtD 2020 performance

  • Performance since the S&P 500 index trough on March 23rd


During the period of time in which COVID-19 was a factor - meaning much of 2020 - you get a very different story on sectors depending on whether you look at the returns since the beginning of the year or since the market reached its bottom around March 23rd. The best performers YtD have – perhaps not surprisingly – been technology (MSFT, AAPL, chip companies, payment companies), communication services (FB, GOOG, gaming companies), consumer discretionary (AMZN, MCD, TGT, HD) and healthcare, all of which performed better than the S&P 500. The first three outperforming sectors have had positive returns YtD whilst the S&P 500 has been down 5.7%. Since the market’s trough on March 23rd, the only two sectors of these four that have remained star performers, beating the S&P 500 during this period, have been the consumer discretionary and technology sectors. More out-of-favour sectors initially in the downturn have in fact rallied, outperforming the S&P 500 since its bottom, including some surprises like energy (+70%), financials (+36.2%), and more cyclical sectors like materials and industrials (which includes airline, aerospace, marine and transportation). Real estate is also not far behind, having just barely underperformed the broader S&P 500 index.

It is also interesting to note that the highest dividend yielding sectors remain energy, real estate and utilities, although I am especially concerned that the yield for the energy and real estate sectors will fall further as some of the component companies will be forced to reduce their dividends in the coming quarters or, even worse, go bankrupt. Nevertheless, it is important to note that over time, the returns on the funds in the table represent the price action of shares only, not dividends, which typically are higher and more stable than share prices for utilities, real estate and energy, perennial underperformers based on price action alone.

One last question you might be asking is how so many sectors from inception have performed better than the S&P 500 index, and conversely, why so many sectors since the beginning of 2020 have performed worse. I did not look back in detail, but I suspect it has to do with the relative weighting. For example, the four sectors that have beaten the S&P 500 year-to-date – communications services, consumer discretionary, healthcare and technology – account for 62.5% of the weighting (by AUM) across all 11 sectors, more than offsetting the poor – and in some cases extremely poor – returns of the other seven sectors. It is hard to imagine that the relative weightings were as concentrated in 1998 as they are today, especially amongst the “tech” names, some of which barely existed in 1998. Also, the dispersion of fund returns is not as broad over the long-term simply because longer periods of time smooth the returns.

The graph below is busy but provides another depiction of the YtD performance on a relative basis of the 11 sectors.


Alternatives to the 11 Sector Funds

There are certainly other ETF sponsors that provide index funds based on the the 11 sectors covered by the State Street SPDR funds, which are based on the accepted Global Industry Classification Standard (“GICS”). State Street also offers 21 Select Industry Indices, that provide more concentrated holdings in sub-sectors like Transportation, Technology Hardware, Telecom, Healthcare Services, and so on. If you want to know more about these industries and sub-sectors, I suggest that you download this paper from S&P dated May 2020, entitled “S&P Select Industry Indices, Methodologies”.

Conclusion

There has clearly been a rotation in the broader equity markets as the worst of the pandemic (from a market perspective) has come and hopefully gone. The sectors that – relatively speaking – benefited the most initially during the self-imposed economic stoppage caused by COVID-19, have given ground to some “less obvious” sectors that were beaten down severely as the market unravelled. It is these sectors that perhaps offer the most upside if the global economy continues to slowly reopen, and the pandemic subsides gradually over time without a second wave.

ETF sectors are an alternative way to play the equity markets if you happen to have more conviction around sectors than specific names. ETF sector funds have very low management fees, too. However, as this article has hopefully shown you, it is very important that you understand the component names in each sector, because in some cases, it is far from intuitive.

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