Family Affair: A Look at Sector Trends

April 16, 2024

6 minute read

by Liz Ann Sonders, Chief Investment Strategist, Kevin Gordon, Charles Schwab & Company Ltd.

While major indexes have seemingly been calm this year, there are notable and stealthy sector leadership shifts that have happened under the surface.

This year is slightly more than four months old, and despite a seemingly calm ride for the market (at least at the index level), there has been considerable churn under the surface. We've written about the weakness seen at the individual member level, but in this report, we'll look a couple levels up at the 11 S&P 500 sectors. The story of subsurface churn is still the same, but there have been key leadership shifts over the past few months, many of which have occurred in a somewhat stealthy way.The chart below shows a year-to-date performance derby for all 11 sectors. You can see that Communication Services is maintaining a healthy lead at nearly 18%, while Real Estate is the only laggard and down by more than 7%.

Real Estate lags

Communication Services is maintaining a healthy lead this year and is up nearly 18%, while Real Estate is the only laggard and down by more than 7%.

Source: Charles Schwab, Bloomberg, as of 4/12/2024.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested indirectly. Past performance is no guarantee of future results.

For the most part, Communication Services has not lost its top spot this year, thanks to considerable performance from a few mega-cap members; the two largest in the sector are Alphabet and Meta, which are the fourth- and sixth-largest companies in the S&P 500, respectively.Perhaps more interesting is the jump Energy has made over a rather short timeframe. As you can see in the chart below, from January through February (shown via the blue bars), Energy was one of the weaker performers with just a 2% gain (outpacing only Utilities and Real Estate). The two dominant performers in those months were Communication Services and Tech. However, since March, Energy has asserted its dominance and is outperforming all other sectors by a wide degree. Not only has its 12.5% gain trounced Tech's 0.7% gain, but it's nearly double the gain for Communication Services.

Energy jumps the line

Since March, Energy has asserted its dominance and is outperforming all other sectors by a wide degree.

Source: Charles Schwab, Bloomberg, as of 4/12/2024.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested indirectly. Past performance is no guarantee of future results.

It's understandable that Energy's swift comeback might be associated with (or due to) the recent jump we've seen in inflation pressures and energy prices. The consumer price index (CPI) reading in March was hotter than expected, confirming that the relatively hot prints in January and February were not blips. Additionally, oil prices (using Brent crude as the proxy) are up by nearly 18% year-to-date.Not only have those factors helped boost Energy's performance, but the sector's underlying breadth also looks quite strong. As shown in the chart below, as of last Friday's (April 12th) close, every member in the Energy sector is trading above its 50-day moving average. For the percentage trading above their 200-day moving average, the share drops to 83%. Even though Financials scores better on the latter metric, you can see the sector is suffering more from a momentum drop of late, given only 44% of its members are trading above their 50-day moving average.

Energy's fresh breadth

As of last Friday's (April 12th) close, every member in the Energy sector is trading above its 50-day moving average. For the percentage trading above their 200-day moving average, the share drops to 83%.

Source: Charles Schwab, Bloomberg, as of 4/12/2024.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested indirectly. Past performance is no guarantee of future results.

Our Sector Views

The relatively strong performance and (long-term) breadth in sectors like Energy and Financials are consistent with what our sector ratings show. For those who might not be as familiar, we recently revamped our Sector Views model and process after a two-year hiatus. As shown in the table below, you can see that Energy, Financials, and Materials are rated as "outperform" while Real Estate and Consumer Discretionary are rated "underperform" (the rest are "marketperform").

Energy, Financials, and Materials are rated as "outperform" while Real Estate and Consumer Discretionary are rated "underperform" (the rest are "marketperform").

Source: Schwab Center for Financial Research, as of 3/18/2024.

The ratings Outperform, Marketperform, and Underperform reflect SCFR's opinions about the likelihood that the sector will perform better (outperform), about the same (marketperform), or worse (underperform) than the broader S&P 500^® index during the next six to 12 months. Sectors are based on the Global Industry Classification Standard (GICS^®), an industry analysis framework developed by MSCI and S&P Dow Jones Indices to provide investors with consistent industry definitions. Sectors are listed in the above chart in order of their performance in five factors that are shown in the chart below. Sectors are part of the Global Industry Classification Standard (GICS) grouping. The classification includes four levels or groupings of companies that make up the U.S. stock market. These groupings (as well as the number of constituents in each category as of April 2023) are as follows: • Sectors (11) • Industry Groups (25) • Industries (74) • Sub Industries (163). The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Investing involves risk, including loss of principal.

Thanks to our colleagues in the Schwab Equity Ratings (SER) department, we're able to look at a variety of factors to help construct our ratings. You can see them laid out in the following table, along with how each sector scores for each factor. This is the quantitative-driven part of the model, which we marry with our qualitative, top-down analysis to arrive at each rating. For context, we don't look solely at the number of negative and positive factor scores for each sector to construct a rating. For example, the Tech sector scores quite poorly in areas like valuation, but we think the sector's higher-quality characteristics (like strong cash positions, among others) should keep it as a "marketperform."

Source: Schwab Center for Financial Research, S&P Dow Jones Indices, as of 3/18/2024.

Sectors are ranked as positive (+), neutral (N) or negative (—) for each of the five factors based on the sector's relative ranking (from 1-11) in each factor: 1-3 is positive, 4-8 is neutral, and 9-11 is negative. See Important Disclosures for an explanation of the Value, Growth, Quality, Sentiment and Stability factors and their inputs. The Schwab Center for Financial Research reserves the right to override the Schwab Sector Views Model.

Paper cuts preferred for cyclicals

We think that cyclically oriented segments of the market can continue to do well as long as our thesis of rolling recessions turning into rolling recoveries remains intact. So far, that continues to be the case, evidenced by the fact that manufacturing sentiment, housing, and capital spending have started to turn a corner after being mired in a slowdown for a couple years.Additionally, we think that once the Federal Reserve starts embarking on its rate-cutting cycle, it is likely to opt for a slow cycle (defined as cutting less than five times in a 12-month period). As shown via our friends at Ned Davis Research (NDR) in the chart below, slow cutting cycles tend to benefit cyclical sectors relative to defensives. In the case of what NDR shows, the cyclical group includes Energy, Materials, Industrials, Consumer Discretionary, Financials, Tech, and Communication Services.

Speed of easing cycles important for sector leadership

Historically slow cutting cycles tend to benefit cyclical sectors relative to defensives while fast cutting cycles have been consistent with significant relative underperformance for cyclical sectors.

Further distribution prohibited without prior permission. All Rights Reserved. See NDR Disclaimer at www.ndr.com/copyright.html. For data vendor disclaimers refer to www.ndr.com/vendorinfo/. 1974-4/15/2024. The chart and embedded tables show broad cyclical and defensive sector performance around first Fed rate cuts. Y-axis is indexed to 100 at start of first rate cut. An index number is a figure reflecting price or quantity compared with a base value. The base value always has an index number of 100. The index number is then expressed as 100 times the ratio to the base value. A fast easing cycle (orange line) is one in which the Fed cuts rates at least five times a year. A slow easing cycle (black line) has less than five cuts within a year. Blue line represents all first cuts. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Past performance does not guarantee future results.

Deep rate cuts would likely be consistent with the Fed responding to unwanted and unexpected weakness in the economy—likely in the labor market. Also shown in the chart above via the orange line is that fast-cutting cycles have historically been consistent with significant relative underperformance for cyclical sectors. That isn't too surprising since a recession-induced bear market would likely send investors piling into traditional defensives (like Consumer Staples and Utilities).

In sum

Investors should be mindful of the large and swift leaderships shifts that have happened under the surface of the major indexes. Our sector ratings continue to favor segments of the market that benefit when the economy is entering a recovery and moving into expansion. Importantly, though, we put an equal amount (if not more) emphasis on the factors mentioned above. Investors should continue to keep an up-in-quality bias when it comes to looking for characteristics like free cash flow yield, profitability, and strong cash positions. We think those factors are among several in the high-quality arena that will do well in a slow Fed cutting cycle.