2022 has been rough for investors. The broad-based S&P 500 was down over 27% from the January peak to the year-low level in mid October, and is currently down about 17% year-to-date. Persistently high inflationary pressures and interest rates around the world acompanied by the looming threat of a recession have soured sentiments and depressed valuations. In this bear market, some sectors have been hit harder than others, while some remain a leading pack, continuing to provide their investors with decent returns in this tough market environment. Let’s take a look at some of the major trends from this year’s stock market.
Winners
Losers
Looking at year-to-date performance of the S&P select sector SPDR ETFs, the trends are reflective of the fact that value stocks such as those from the Energy sector historically outperform growth stocks during periods of rising rates. It is also evident fund flow has remained in defensive sectors with the Consumer Staples ETF (XLP); Utilities ETF (XLU) and Health Care ETF (XLV) only marginally down from the previous year as compared to the big losers such as the Communication Services ETF (XLC), Consumer Discretionary ETF (XLY), Real Estate ETF (XLRE) and Technology ETF (XLK).
As the year draws to a close and we move into 2023, a question on investors’minds will be which sectors could outperform the broader market next year.
To understand the potential winners for next year, we should first seek to understand the concept of sector rotation analysis, which attempts to link current strengths and weaknesses in the stock market with the general business cycle based on the relative performance of the 11 S&P Sector SPDR ETFs. The business cycle influences the rotation of stock market sectors and industry groups where certain sectors perform better than others during specific phases of the business cycle, and this can help investors position themselves in the right sectors to maximize their returns.
The graph above shows the economic cycle in blue and the stock market cycle in orange, with the best performing sectors in various stages of the cycle above. The blue economic cycle corresponds to the business cycle and the orange market cycle leads the business cycle, where the market turns up and crosses the centreline before the economic cycle turns. Similarly, the market turns down and crosses below the centreline ahead of the economic cycle.
From the market this year, we saw relative strength in Energy, Consumer Staples and Healthcare which coincided with the economic cycle and stock market cycle phases of full recovery and market top respectively. These sectors benefitted from a rise in commodity prices and a rise in demand from an expanding economy, while we also saw the tipping point for the market when consumer staples showed strength, a sign that commodity prices are starting to hurt the economy.
Hence, the sectors that could outperform next year are Utilities, Financials and Real Estate as the market peak and full recovery are followed by a bear market downturn and contraction in the economy, with recessionary fears looming large currently. If the Fed pivots from its hawkish monetary stance, the easing interest rates will benefit utilities and real estate sector which typically take on a high proportion of debt. The steepening yield curve also improves profitability at banks and encourages lending, giving a boost to financials as well.
To conclude, the main winners from this year’s market were value stocks in Energy and defensives comprising Healthcare, Defence and Consumer Defensive sectors as we approached full recovery in the economic cycle and a top in the stock market cycle. With that, we could see relative strength shift to Utilities, Financials and Real Estate sectors next year should we enter into an early recession in the economic cycle and remain in a bear market.
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I analyze the stock market and conduct technical analysis to provide investment recommendations. I look forward to having a conversation with you in our in-house seminars and presentations to identify good risk-reward trading strategies together. I graduated from Nanyang Technological University with a Bachelor of Accountancy (Honours).
