While there are nearly as many ways to slice and dice the stock market as there are analysts on Wall Street, one of the best is still the simplest. The 10 Select Sector SPDR exchange-traded funds break the market down into digestible chunks with just enough granularity to point out opportunities.
It is no surprise that technology led the pack for much of this year and the Technology Select Sector SPDR Fund (NYSEARCA:XLK) is still up 22.6% year-to-date vs. 13.4% for the S&P 500 Index. However, despite setting new all-time highs throughout September and so far in October, it actually underperformed the market since late August.
Since the broad market itself continues to set record after record, other sectors must have taken over the mantle of leadership and indeed we can use these ETFs to prove it.
Energy Sector
Let’s take the late August peak in relative performance of the tech sector as our starting point. The top group since then is energy and the Energy Select Sector SPDR Fund (NYSEARCA:XLE) beat the market by about 7%.
Click to Enlarge This ETF peaked last December and suffered a private bear market by falling roughly 20% to its low this past August. As we can see in the chart, it broke out in September through its falling trendline and the new trend does look established to the upside.
Since oil itself does not appear to have a similar bullish stance and it more likely rangebound, the conclusion is that money fled the arguably overvalued tech stocks and moved into sectors deemed as “value.”
Indeed, energy’s low price relative to the rest of the market is one reason and now that the technicals have turned for the better we can see how money would continue to flow in here.
A rather beefy 3.1% dividend yield for the ETF is a bonus.
Financial Sector
The next top sector ETF is Financial Select Sector SPDR Fund (NYSEARCA:XLF) led by the banks. Insurance stocks were hammered in the aftermath of Hurricane Harvey in Texas and Louisiana and banks fall in sympathy. In fact, some measures of the banking industry actually scored technical breakdowns in early September.
Click to EnlargeHowever, the bulls quickly recovered and sent banks and the entire financial sector higher. The rally was steep. It took the financial ETF to new highs and to the top of the performance ranks.
The fundamentals back this up as interest rates finally responded to the Fed’s promise to unwind the liquidity plan it began after the financial crisis in 2008. More importantly, the yield curve, which in its simplest form measured the difference between long-term and short-term Treasury rates, also steepened a bit.
This is a critical component for banking profits as they borrow at low short-term rates and lend at higher long-term rates. Banks certainly like a steeper curve and their stocks respond in kind.
Bottom Sectors
That brings us to the bottom performers. While technology fell from the top of the leader board, it is still very much in the game. The bottom sector right now is consumer staples followed by utilities.
Both consumer groups – staples and discretionary – lagged the market for months but something changed in late August. Tech stumbled and utilities fell apart to take over the second worst performance spot.
Consumer Staples Sector
The Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP) tracks stocks in defensive areas such as tobacco, food, drug stores and household products. Companies here enjoy more stable demand. People use their products with less regard for economic swings. They don’t put off a soap or medicine purchase as they would a television or new furniture.
Click to EnlargeAs such, these stocks tend to hold up better during uncertain economic times but lag when everyone feels confident. With the broad stock market at record highs, it is no surprise that the staples ETF lags the rest.
It is one of the few sector ETFs that did not move to new highs this month. In fact, it is still down about 5% from its best levels over the summer. Compare that to the market’s 4% gains over that same span.
Utilities Sector
Second from the bottom is the Utilities SPDR Fund (NYSEARCA:XLU) and its fall over the past month was indeed dramatic.
Click to EnlargeThe main reason is the sharp shift in the trend of long-term interest rates. The benchmark 10-year Treasury yield bottomed in early September at 2.06% and suddenly jumped higher. It now sits at 2.35% and that is a big move.
Utilities may have changed their business models but they remain quite sensitive to changes in interest rates. The good news is that the major trend in the utilities ETF is still to the upside. Still, in an environment where the Federal Reserve committed to normalizing rates utilities should continue to lag the rest of the market.
What It Means for the Stock Market
With tech giving way to financials, and energy finally joining the bull market, the overall condition of the market remains good. Also, with two traditionally defensive areas – staples and utilities – lagging, that conclusion is strengthened.
Investors can track the relative performances of the sectors to follow the money. Right now, the flow is to financials and energy.
As of this writing, Neil Martin did not hold a position in any of the aforementioned securities.
