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Reviewing Sector Performance in 2021 and Positioning in 2022

Reviewing Sector Performance in 2021 and Positioning in 2022

A LOOK AT SECTOR PERFORMANCE

Every single U.S. sector, as determined by S&P Dow Jones Indices, posted gains in 2021. You heard that correctly, every single one! Of course, each sector doesn’t move in unison, so let’s explore this a bit further. 

The energy sector was the big winner in 2021, whether it be large-cap, mid-cap, or small-cap companies. They posted 2021 gains of 53.4%, 71.3%, and 60.0%, respectively. Real estate also had a solid 2021, posting gains of 46.2%. 

One thing that we talk a lot about is cyclicality and reversion to the mean. When we are talking about sectors, cyclicality means that sectors generally go in and out of favor. Said another way, a sector that outperforms one year may underperform the following year or vice versa. For example, let’s look at what energy did in 2020 (keep in mind we just talked about it being the big winner in 2021). Returns for large, mid, and small-cap energy stocks were -32.8%, -42.8%, and -40.0% respectively. From 2020 to 2021, energy went from the worst-performing to the best-performing sector. 

Financials is a sector that many are looking at opportunistically in 2022. The reason being is that banks are one of the few places that benefit from rising interest rates. One of the key points to take away is that it’s unlikely that a single sector can consistently be the “winner” year-in and year-out over the long haul.

A Look at Factor Performance

Factors are another variable, like sectors, that move in and out of favor. Most people are familiar with sectors, but might not be able to list as many investment factors off the top of their heads. BlackRock describes factor investing as “an investment approach that involves targeting specific drivers of return across asset classes.” Factor investing is not passive; one tries to find attractive attributes of a security that will enhance returns and/or reduce risk. There are macroeconomic factors and style factors. Similar to the sector discussion above, each of the seventeen factors (among S&P 500 companies) delivered positive returns in 2021. The top performing factor in 2021 was High Beta, at 40.9%. 

One item that many clients have asked about over the last several years is growth versus value. Growth has dominated value in recent memory, including in 2020 when it outperformed value with a 33.5% return vs. 1.4% return. In 2021, S&P 500 growth again outperformed S&P 500 Value, 32.0% to 24.9%. In 2022, we might see growth and value continue to have less of a dispersion compared to the 2010s, where growth significantly outperformed value. Momentum, the worst performing factor in 2021– granted it still produced a 22.8% return – was the third-best performing factor the year prior when it returned 28.3%. Momentum is another good example of a factor that outperformed the general index in one year (2020), only to underperform the index the following year (2021). 

Where to go from here?

Does this mean that you should only own energy? Or only own high beta? Of course not. There is generally a reversion to the mean. Again, most investors need exposure to a diversified portfolio and a disciplined investment process. Rebalancing is one technique to help take small gains over time and not become too concentrated on a single sector or factor. 

Note that diversification doesn’t imply that owning every sector equally-weighted is always the best approach, either. If you own an S&P 500 index fund, you own every sector, but in different weights. If we’re looking at the end of 2021, 29.2% of your S&P 500 exposure would be in information technology alone. Also, keep in mind that true diversification includes more than just sector diversification. Having a mix of uncorrelated assets from a geographic, asset class, and allocation perspective must all be considered when building a diversified portfolio.

Mitch DeWitt, CFP®, MBA

2022 Investment & Market Outlook Guide

Mitch DeWitt’s piece is part of Walkner Condon’s 2022 Investment & Market Outlook Guide, a comprehensive reflection of 2021 and glimpse at the factors impacting the year ahead in 2022.

Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Markets within Markets: Assessing the High Levels of Dispersion in Stock Valuations

Is the market cheap or expensive? This simple question is a constant source of debate among investors, who search endlessly for clues to support their bullish or bearish views. With stock prices hovering around all-time highs, and common valuations ratios for the S&P 500 index at levels not seen since 2008, I would be somewhat hard-pressed trying to make the case that stocks are historically cheap. That said, growth prospects in the economy can, in theory at least, justify just about any valuation level. 

One significant challenge in assessing today’s markets is the very high level of dispersion in stock valuations. While the market overall may look pricey, the picture gets murkier if we look under the hood to consider individual market components. Increasingly, different sectors that compose some of the main stock indices are behaving like totally different markets, and while that is always the case to some extent, the current level of disparity hasn’t been seen in decades. 

In its recent quarterly market report, JP Morgan provides some great data to illustrate the current situation. Since 1996, the level of valuation dispersion (defined as the difference between the 20th and 80th percentile) for stock valuations in the S&P 500 has been 11.0 on average; today the current valuation spread is 19.7. As shown below, the spread is the highest it’s been since 1996, and you’d need to go back over 20 years, to the early 2000s, to find comparable dispersion.

In practice, it means that in today’s world, a sector like consumer discretionary (which includes Amazon and Tesla), is more than twice as expensive as some of the cheaper sectors, like financial services or energy.

The theme of valuation spread yields equally striking results when considered from a different angle: country and regional valuations across the world, rather than between U.S. sectors. As shown in the chart below, the valuation spread between the most expensive region (the U.S.) and the cheapest (emerging markets) is currently at levels not seen since, once again, the early 2000’s.

What should investors make of this increasingly disparate world? Investing would be much easier if we only had to look for cheap valuations to infer future returns, but in fact, cheap stocks may turn out to be value traps. Valuation metrics such as Price to Earnings ratios (PE) are meaningless in isolation, and must always be interpreted in the context of a company’s growth prospects. In other words, high valuation levels aren’t necessarily “expensive”, and low valuations aren’t necessarily “cheap,” just like an inexpensive used car isn’t always a good deal. 

In recent years, buying the most expensive stocks has been the winning strategy, as they continuously grew into higher and higher valuations. Every trend eventually comes to an end, and extreme positioning could be an early sign of a potential reversal. The early 2000s were, in hindsight, a transition period between the roaring 1990s and the lost decade of the 2000s. Eventually, paying an ever-growing premium for trendy stocks will leave investors chasing increasingly unrealistic growth targets. In the context of a well-diversified portfolio, it might be time to take a closer look at today’s unloved stocks, with a bit of luck, we might just find a good deal.

Syl Michelin, CFA®

The Evolution of the S&P 500: Where Do We Go From Here?

The Evolution of the S&P 500: Where Do We Go From Here?

The year of 2020 was a very strange one indeed. For the U.S. stock market, however, if you looked at the beginning and the end of 2020, you’d see the S&P 500 up about 16.6% and conclude that this year was merely more of the same ol’ U.S.-dominated bull market that prevailed throughout the prior decade as U.S. stocks led global markets out of the very deep bear market experienced during the Great Recession. The leadership experienced by the blue chip S&P 500 stocks over smaller stocks indeed persisted in 2020 just as large caps have outperformed small and mid-cap stocks over the bulk of the post-recovery bull market. The similarities don’t end there, as 2020 was a year again dominated by winning sectors within the S&P that have been doing the heavy lifting for quite some time, led by mega cap darlings that epitomize innovation and success in their dominance of our digital economy. Here are the top three sectors ranked by performance in 2020:

  • INFORMATION TECHNOLOGY (THINK APPLE & MICROSOFT) +42.8% +42.8%
  • CONSUMER DISCRETIONARY (THINK AMAZON) +32.3% +32.3%
  • COMMUNICATIONS SERVICES (THINK ALPHABET, FACEBOOK & NETFLIX) +22.4% +22.4%

Yes, those predicting the demise of “FANG” stocks are going to have to wait at least another year (or another 10 years) for vindication, because COVID-19 not only caused investors to gravitate toward what few stocks were still showing earnings growth, it actually caused businesses and consumers alike to lean even more heavily on the digital economy in their day-to-day affairs to navigate the new reality of pandemic, lockdowns, and social distancing. Indeed, it’s entirely fair to say that many of the trends that had long benefited the digital economy stalwarts, such as the migration to social media, streaming entertainment, online shopping, etc. truly accelerated further because of the Covid-induced recession.

On the other side of the coin, 2020 and the Covid-induced recession predictably brought on hard times for those parts of the S&P that contracted sharply from an environment of staying at home, shopping online, and near-zero prevailing interest rates. These are the three worst performing sectors of 2020, which all managed to finish in the red (as did utilities) in a well above average year for the S&P 500 on the whole (percentages shown are negative):

  • ENERGY (THINK EXXON, CHEVRON & SLUMBERGER): 36.9% 36.9%
  • REAL ESTATE (THINK SIMON PROPERTY GROUP & MARRIOTT) 4.6% 4.6%
  • FINANCIALS (THINK JP MORGAN CHASE & BANK OF AMERICA 3.8% 3.8%

So, we see that 2020 was a year that no one will likely ever forget, and yet, from the perspective of the S&P 500 index, it was very much a continuation of 2019 and before, with the largest growth stocks leading a new digital economy and doing almost all of the heavy lifting underneath the surface of a rampaging S&P 500, while value/dividend investors suffered yet another disappointing year of dramatic underperformance.

Let’s put this technology-driven trend in proper perspective, comparing the S&P 500 at the dawn of the post-Great Recession recovery to the end of 2020. Pulling figures from this blog from DataTrek research last March, let’s consider the migration during this nearly 11-year period for the leading and lagging sectors of 2020 in terms of their share of the overall S&P 500. Keep in mind, of course, that the communications services sector did not exist in 2009, so we’ll follow DataTrek’s appropriate and reasonable lead and put Alphabet and Facebook back in the technology sector, and return Disney, Comcast and Netflix back to the consumer discretionary sector (leaving the traditional telecom stocks out of the equation as there is no comparing the old telecommunications sector with the current “communications services” sector). Likewise, real estate was not a recognized separate sector in 2009, so we must also return the real estate stocks to the financials sector to fairly compare 2009 and 2020 figures. Here are the approximate weightings in the S&P 500 for the traditional technology and consumer discretionary winners of 2020 and the energy, real estate and financials laggards of 2020 vs. their relative S&P 500 weightings in March of 2009 (the dawn of the great bull market recovery):

SECTOR WEIGHT END-OF-YEAR 2020 WEIGHT END-OF-Q1 2009
TECHNOLOGY

32.3%

18.0%
CONSUMER DISC. 14.2% 8.9%
ENERGY 2.3% 13.0%
FINANCIALS 12.8% 10.8%

Those numbers put the two obvious megatrends at the sector level within the S&P into a clear numerical perspective. First, technology was the largest sector at the dawn of the post-Great Recession bull market, and its share of the S&P 500 pie has somehow doubled in size during this period to now constitute nearly one-third of the index. Second, companies that extract dinosaur fossil materials (energy) from the earth are now on the verge of extinction within the S&P, as energy’s sector weighting declined about 82% during this period.

As Clint’s discussion of the electric car megatrend thoughtfully points out, Teslas consume energy, too, right? Clearly, the secular and technological changes in the industry that brought oil below $20 at one point in 2020 have dramatically altered investors’ appetites for crude and its derivative products, and the ESG trends that Mitch discusses clearly aren’t helping, either.

Trends persist, often much longer than most imagine they can persist, and this has been a classic example within the S&P 500 for years. However, there is no bigger curse for investors than to be late to the party. Even the most persistent trends eventually give way and reverse course, and often violently. Think NASDAQ circa 2000 with the pricking of the internet bubble. That was a painful time for many investors that bought into the idea that the secular trend of internet adoption would rewrite the rulebook on investing and that traditional fundamental analysis of technology/internet investments was no longer applicable. This was an age when I distinctly remember repeatedly hearing the most dangerous four-word sentence on Wall Street: “This time it’s different.”

Would we dare utter those words today? What if I told you that the Information Technology sector of the S&P 500 in December was trading around 45 times trailing one-year earnings, and about 40 times the estimated earnings for the coming year, while the Consumer Discretionary sector was trading at 85 times trailing one-year earnings and 38 times estimated earnings for the coming year? That seems quite frothy indeed. This illustrates a major premium that has been paid (and continues to be paid) for growth, not at a reasonable price, but at any price, in a world where there was (and there remains) a scarcity of growth (i.e., the Covid-induced recession). 

However, there are many metrics by which we can judge the current S&P 500 in the context of history. I recently revisited one thoughtful article from October 2018 by a very seasoned Wall Street veteran who expressed concern about the froth within the S&P 500 back in 2018, echoed my revulsion of the most dangerous sentence ever heard on Wall Street, but keenly observed that adjustments in historical time frames could dramatically alter the perception of relative froth in the S&P 500. There truly is a data point for every argument.

Therefore, as we happily put 2020 in our rearview mirrors and look to the future promise of 2021, what can we expect for the S&P 500 and its component sectors? Prognostications are dangerous and common sense negates the follies of both ignoring a trend and blindly riding a trend into oblivion. In other words, it would be unwise to overly commit to the notion that, because the S&P 500 has led world stock markets, and technology, communications services, and consumer discretionary stocks have dominated the S&P, that you should cash in your chips and place all bets elsewhere. On the other hand, the magnitude of the outperformance of the S&P 500, and particularly of those sectors and mega cap stocks most responsible for that outperformance, has increased the risks associated with those investments relative to other sectors within the S&P 500 and relative to other stock indexes, foreign and domestic. 

The prescription for navigating the market ahead is an ageless remedy:

  • Examine your portfolio and the underlying allocations to U.S. stocks, to sectors within those U.S. stock holdings, to non-U.S. stocks, to bonds, to alternative investments, etc.;
  • Determine the extent to which the trends discussed above have left your portfolio over-exposed to U.S. stocks and particularly to the growth stocks and the favored growth sectors that have led the S&P 500 to new heights in 2020; and
  • If you determine that the weightings in your portfolio make you uncomfortable with the potential eventuality that money flows reverse away from these investments into more neglected segments, sectors, and regions within the global stock markets, then by all means REBALANCE — sooner, rather than later.

Given the new highs for all the major stock indexes in the U.S., it is probably safe to assume that investors, in general, are anticipating a smooth rollout of Covid vaccines as we move into 2021 and a major economic rebound as life starts to return to something resembling normal. If this occurs, we could very well see outperformance in sectors of the S&P 500 that massively underperformed in 2020, and that could very much come at the expense of 2020’s market stalwarts. After all, for money to move to the less-loved sectors of the S&P, it has to come from somewhere and, right now, practically one-half of the money in U.S. blue chips is in technology (infotech and comm. services) and consumer discretionary stocks. More breadth in a rising market would be quite welcome. However, only time will tell whether and to what extent the underlying economy will have a robust recovery and to what extent the current pandemic has produced long-term fundamental shifts within the economy that could provide continued challenges for certain sectors and industries within the domestic and global economy. 

Stan Farmer, CFP®, J.D. 

2021 INVESTMENT & OUTLOOK GUIDE

This piece was part of Walkner Condon’s 2020 Review & 2021 Investment Outlook Guide, a comprehensive interactive PDF covering a wide range of subjects and trends, including the S&P 500, electric cars, and more. To read the full guide, please click the button below.