Sector rotations—mass movements of investors into and out of stocks (and ETFs) from certain industries—have been at the top of everyone’s mind lately as the market recovery appears to be shifting away from its prior tech-driven growth. While the broad market has rallied since March lows, specific sectors have experienced longer periods of divergence and outperformance or underperformance. Below are a number of winners and losers and an exploration of why investors rotated into or out of those sectors, and where they could go next.
Energy & Commodity Stocks
The collapse in commodities is the granddaddy of the recent sector rotations, with the sector’s biggest losses coming as oil prices crashed and futures briefly traded at negative values in early 2020. Commodity stocks continue to rattle around historic lows as they face a seemingly endless slate of challenges, and while the prices of some of commodities remain at or near their lowest levels in years, others have begun to rally, pointing to possible sector rotations back into certain areas like metals and miners. There has been limited subsector advancement but it hasn’t been enough to drag the broader sector out of the doldrums, as you can see in the 10-year chart of PowerShares’ commodity index fund below.
Commodity investors are pricing in a broader economic recovery but early evidence from China points to a largely industrially driven recovery which is leaving consumers behind. This could easily lead to ongoing subsector divergence as iron, lumber, and copper prices rapidly rise while the prices of consumer-driven commodities (like meat) continue to stagnate.
Healthcare and Biotech
Healthcare is another area where broad sector performance belies the performance of the underlying industries. As a whole, healthcare has lagged the performance of the S&P 500 year-to-date, but that’s largely been driven by the arrival of the pandemic and associated changes to how individuals consume healthcare. Biotech, as an industry, is flat on the year as resources (and investor dollars) have been funneled away from the discovery of novel therapeutics into the development and distribution of a coronavirus vaccine as well as the associated infrastructure. Where healthcare investors have thrived, however, is in the pharmaceutical and drug discovery space as the world rushes to develop a vaccine. A popular option for investors looking to gain exposure to biotechnology and pharmaceuticals is the iShares Nasdaq Biotechnology ETF (IBB) which has actually outperformed the S&P 500.
IBB is significantly outperforming biotech due to the ETF’s exposure to a large number of vaccine manufacturers. While powerful in the short term sector rotations into coronavirus solutions seem likely to reverse in the intermediate term once a vaccine is widely distributed (or distributable) and consumers return to healthcare as normal.
Rotation out of financials early this year was rapid and investors have been slow to return. A combination of uncertainty about the pace and breadth of a broader economic recovery and a persistently low interest rate environment have kept financials out of the larger market rally. Financials have rallied off their lows but are still negative on the year despite what looks like double digit returns elsewhere in the equity markets.
The rotation out of financials was fast and painful and financials have underperformed on the year. The fed is unlikely to rock the boat with unexpected interest rate increases, but further economic stimulus could potentially offer financials a boost in the near term.
Conservative, high-yielding equities including telecoms, utilities, and many consumer staples stocks were largely left behind in the rush towards growth companies as consumers were forced to stay home and work and learn online, but once the market fully prices in the anticipated economic recovery, these high-yield stocks could present a lot of value in a world without many fixed-income alternatives.
With interest rates low now, and likely low for the foreseeable future, high-yield stocks are likely to look attractive as growth stock appreciation makes more and more value investors nervous. Market-wide cash flow trends point to full or nearly-full equity investment which, if not a near-term market top, could at least signal slower growth and could cause investors to look for undervalued assets and income opportunities elsewhere. With the market trading near all-time highs we could be finding ourselves looking at a sector rotation into more conservative investments in the weeks and months ahead.
Retail & Consumer Discretionary Stocks
Stop me if you’ve heard this before, but recent performance of retail and discretionary stocks paints a picture of sector divergence. The oft-predicted death (or at least decline) of brick and mortar stores was greatly accelerated by the pandemic, but discretionary stocks are actually outperforming the S&P 500 this year. There are a number of factors at play here, but the most significant is the further transition to online retail. Just because consumers couldn’t shop in retail stores doesn’t mean they were done shopping. Plus, significant cuts to other discretionary spending (like bars, restaurants, and travel) left many consumers with extra money in their pockets and a desire to upgrade their home offices, gyms, and leisure spaces.
Like most of 2020, sector rotations this year have been somewhat unpredictable. In all likelihood this is attributable to the unique nature of the changes we’ve been required to make. The pandemic has been all-consuming, including our investing portfolios, and while it’s likely to have accelerated changes in quite a few consumer behaviors, it’s unclear just how much it’s disrupted traditional valuation metrics and what changes that will lead to for investing in the future.
*This post has been updated from a previous version.