By Simon Constable
Stock-market sectors generally don't move in strict
synchronization. Some will lead as others lag behind, and a key
question for investors is which sector is poised to move up fastest
next.
In the bull market that started in late March, the technology
sector initially led the way, with companies such as Amazon.com
climbing faster than the rest of the market. Technology Select
Sector SPDR (XLK), an exchange-traded fund that tracks an index of
technology stocks, surged 73% from March 20 through Aug. 31, while
the S&P 500 index advanced 52% over the same period, according
to Dow Jones Market Data. Because tech is such a significant part
of the S&P index -- accounting for one-fifth to one-fourth of
the weighting -- that means many of the other stocks in the index
performed far worse than the index itself.
Of course, nothing stays in the lead forever, and one sector
rarely sustains a rallying market. Veteran investor Ralph Acampora
is famous for saying "rotation is the lifeblood of bull
markets."
Already there has been some rotation, according to JC Parets,
president and founder of technical-analysis company
Allstarcharts.com. Technical analysts try to forecast future price
movements by looking at patterns in stock-price charts.
For much of August, the Dow Jones Transportation Average
outperformed the tech sector and the S&P 500 as investors
rotated into transport stocks. That said, by month's end investors
seem to have resumed their love affair with tech stocks. The
transportation average rose 12% in August, the same as the 12% gain
for the Technology Select Sector ETF and a 7% increase for the
S&P 500. Then, techs faltered as September began.
So which sector is poised to lead the market higher next? As
usual with the stock market, the answer depends on whom you
ask.
1. Cheaper midcaps
Swiss bank UBS Group AG says shrewd investors should look for
sectors with cheaper valuations such as midcaps to start playing a
greater leadership role.
"As the global recovery gradually takes hold, the next leg up in
the market may be driven by cheaper sectors that have trailed
behind in the rebound, such as cyclical and value stocks," a recent
research report from the bank said. "As a result, we like U.S.
midcap stocks, which look poised to regain lost ground as the
economic recovery gains traction and broadens out."
Midcaps are often defined as stocks with a market value between
$2 billion and $10 billion. From the start of the bull market on
March 20 through August, iShares Russell Mid-Cap ETF (IWR), which
tracks the Russell Midcap Index, has returned 54%, lagging behind
tech stocks but performing a little better than the S&P
500.
But if history is any indication, midcap stocks could start to
take the lead if the economy improves.
In the two decades through December 2019, the Russell Midcap
Index's total annualized return of 9.1% topped that of both the
S&P 500 and the Russell 2000 small-cap index, according to data
from UBS.
2. Look overseas
International stocks look like a good bet for future market
leadership for three reasons, according to Jack Ablin, chief
investment officer and founding partner of Chicago-based
wealth-management form Cresset Capital.
First, the economic situation is currently better outside the
U.S. than inside, he says. While the American economy has rebounded
somewhat since the crash in the second quarter, other countries
have gone beyond rebound and into a real recovery, he says.
Second, foreign stocks tend to be cheaper than U.S. stocks
currently. "International equities might not be cheap, but they are
cheaper on a relative basis," he says. "We are moving from
something expensive to not quite as expensive."
For example, the price of stocks as a multiple of what investors
expect them to earn in the next year (the forward price/earnings
ratio) is higher in the U.S. than in the other regions. The forward
P/E for the MSCI index in the U.S. is 22.7, versus 18 for Japan and
17.7 for Europe, according to a report from Yardeni Research.
The third factor that favors non-U.S. stocks is a weakening U.S.
dollar, says Mr. Ablin. If the dollar is going down, owning stocks
that are priced in currencies that are rising in value is a better
bet for investors.
There is, however, a wrinkle that investors should understand
when buying non-U.S. stocks, according to Mr. Ablin. Rather than
investing in funds that simply track local country indexes, he
advises adjusting non-U.S. holdings to give a greater weighting to
tech companies. A little more than half of the underperformance of
non-U.S. markets relative to U.S. markets over the past 10 years is
due to foreign markets having less exposure to tech companies,
according to an informal study conducted by Cresset.
As such, investors buying outside the U.S. might want to seek
out tech stocks rather than just buy country or regional index
funds. A few to consider, according to Mr. Ablin: LM Ericsson,
Taiwan Semiconductor Manufacturing Co., Tencent Holdings Ltd., SAP
and Alibaba Group Holding Ltd.
3. Election influence
This year features a presidential race in the U.S., and there is
some useful historical data back to 1992 on which sectors tend to
do well in the three months before an election.
"Energy and financials beat the market most frequently in the
[three] months before the election, followed by health care and
industrials," says Sam Stovall, chief investment strategist at New
York-based financial analysis firm CFRA Research.
Based on the past, there is one sector that investors should
consider avoiding over this period. In the three months before
voting day, consumer-staples stocks, such as toothpaste
manufacturers, have lagged behind the S&P 500 in five of the
past seven presidential elections, according to an analysis by Mr.
Stovall. The two times the sector did better than the S&P 500
were in 2000 and 2008, respectively, the years of the dot-com bust
and the financial crisis that took hold in September 2008.
Mr. Constable is a writer in Edinburgh, Scotland. He can be
reached at reports@wsj.com.
(END) Dow Jones Newswires
September 06, 2020 11:14 ET (15:14 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.
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