The Next Sector to Outperform the Market

The market rebound, which began in March, has so far increased the value of the S&P 500 by about +55%. Economic indicators are still weak, but the market tends to lead the recovery by several months.

Despite the worry, cyclical stocks — those affected by the economic cycle — are up sharply. Financials are up +146%, industbils are up +74%, consumer discretionary is up +70%, and technology is up +55%. On the other side of the spectrum, defensive stocks — those generally thought to be immune from the underlying economy‘s swings — have underperformed. Utilities, for example, are up just +30%. Staples are up +31%. Health care is up +31%.

This is what the beginning of bull markets look like.

In the early stages, high-tech and industrial shares outperform. As the bull gains legs, basic-industry stocks enter the picture. At the peak, energy and metal companies outperform.

In bearish periods, consumer staples and service stocks outperform. On the way down, it’s utilities. Near the bottom, financial and consumer cyclical stocks lead the pack.

During the past three months, the story has been largely the same as it has since March. Financials have beat the S&P by 10.6 points, industrials by 6.5 points, and consumer discretionary by 4.7 points. All other sectors have lagged, although technology hasn’t lagged by much (-0.7 points).

If history means anything and the bull is real, going forward cyclical stocks will continue to outperform the market and defensive stocks will lag. That means you’ll continue to want to hold shares of companies in industrial, consumer discretionary and technology companies.

But in particular I think there’s a real opportunity in technology because of how it has lagged other cyclical sectors since March. Up +54% since March, tech has performed just slightly worse than the S&P (+55%). That’s unusual for this stage of the market cycle, and that could change quickly.

For broad coverage in this sector, an ETF like the Technology SPDR (NYSE: XLK) does the trick.