Your Best Sector Bet Going Into Year’s End

by Serge Berger | December 4, 2012 9:21 am

With just four short trading weeks left in the year, let’s take a look at how the S&P 500 sectors are faring and what they might look like going into year’s end.

Of the nine sectors in the S&P 500 that I track using the SPDR sector ETFs, seven are higher by roughly 10% to 20% year-to-date. The two underperforming sectors year-to-date are energy and utilities, which have been off and on for much of 2012. The leaders to the upside are financials and consumer discretionary stocks, both of which are up more than 21%.

Here’s a full look at S&P 500 sector performance year-to-date:

S&P Sector SPDR ETF Last YTD Return
Consumer Discretionary XLY 47.30 +21.81%
Financials XLF 15.70 +21.23%
Healthcare XLV 40.13 +16%
Technology XLK 29.09 +14.46%
Consumer Staples XLP 35.91 +10.93%
Industrials XLI 36.77 +10.02%
Materials XLB 36.00 +9.55%
Energy XLE 70.61 +2.79%
Utilities XLU 35.10 -1.83%

Given the risk-on/risk-off toggles on the part of investors in recent years (courtesy of central central banks worldwide), it should not be entirely surprising to see a fairly high correlation among the S&P’s sectors. This is clearly depicted on the multi-sector chart below:

Most sectors have moved from the lower left to the upper right on the chart in 2012, following the green arrow. The notable slacker among the group — utilities — has deviated from the pack. Even though the sector has seen a good rebound in the past two weeks, it remains an underperformer. There are a multitude of reasons for this, ranging from concerns on tax hikes (fiscal cliff) on dividend-paying stocks to the classic case that defensive sectors such as utilities tend to lag in an uptrending broader market.

Given the high correlation among sectors, though, where should you put your money going into year’s end?

From a mean-reversion point of view, one would have to give the utilities a fair chance. However, I think there are too many moving pieces regarding the Utilities Select Sector SPDR (NYSE:XLU[1]) right now. Instead, I favor the cyclical sectors, which would have to perform significantly if we’re to see further green on our screen through the holidays.

Specifically, from a technical point of view, the industrial sector looks poised for further upside into year’s end.

Despite having formed a somewhat concerning daily candle on Dec. 3, the Industrial Select Sector SPDR (NYSE:XLI[2]) still is trading near its highs for the year and thus is showing relative strength. Furthermore, the longer-standing triangle formation on the chart shows a series of higher lows. A break above the resistance line near $38 would be a significant breakout.

The transportation stocks — depicted via the iShares Dow Jones Transportation ETF (NYSE:IYT[3]) — are part of the industrial sector. Their chart is showing a similar pattern to that of the industrial sector chart above, where a solid break above $92 would also be a significant breakout.

In summary, should the broader market see further gains in the remaining weeks of 2012, the continued high correlation among sectors leads me to favor the industrial sector, given its relative strength but not yet entirely overbought levels.

Tomorrow, we’ll follow this up by discussing one industrial stock to buy and another to avoid going into the end of 2012.

Serge Berger is the head trader and investment strategist for The Steady Trader[4]. Sign up for his free weekly newsletter here[5].

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