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

1. Energy – This sector has been the noticeable standout and performed significantly well since the beginning of the year, as sanctions on Russia due to the Russo-Ukrainian War, which started in February, impacted oil and gas supplies resulting in sharp price increases. The top performing energy stocks include Occidental Petroleum (OXY) up 121% year to date (YTD), giants Exxon Mobil Corporation (XOM) and Chevron Corporation (CVX), which rose 69% and 46% YTD respectively.
2. 1. Healthcare – Drug manufacturers also performed better than the overall index, with the standout stocks being Merck & Co (MRK), Eli Lilly and Company (LLY) and Bristol-Myers Squibb Company (BMY), which gained 42, 33 and 28% YTD respectively.
   2. Aerospace & Defence – The aerospace & defence sector led the industrial picks which remained well in the green. The top 3 gainers were Northrop Grumman Corporation (NOC) +37%; Lockheed Martin Corporation (LMT) +36% YTD and Huntington Ingalls Industries, Inc. (HII) +26% YTD.
   3. Consumer Defensives – The traditional defensive sector also performed slightly better than the broad-based gauge, with the top gainers coming from packaged foods, beverages and discount stores. Lamb Weston Holdings, Inc. (LW) was the top performer in this sector +36% YTD; and Coca-Cola Company (KO) and PepsiCo, Inc. (PEP) were up 7% and 4% YTD respectively. Walmart Inc. (WMT) +3% was a shining star amongst the discount store companies with its competitors Costco Wholesale Corporation (COST) and Target Corporation (TGT) in the red this year.

    

   Losers

   1. Technology (Software, Semiconductors, Communication Services) – Growth and big tech stocks were the biggest losers that dragged down the index this year, as the value of future earnings were impacted by rising interest rates, which increased the cost of capital. Semiconductors also slumped this year with piling inventory owing to declining sales. Notable top losers were Meta Platforms Inc. (META) -66% YTD; Advanced Micro Devices Inc. (AMD) -51% YTD; NVIDIA Corporation (NVDA) -45% YTD; Salesforce Inc. (CRM) -47% YTD; and Adobe Inc. (ADBE) -41% YTD.
   2. Consumer Cyclicals – This sector also underperformed compared to the overall index due to slowing economic growth. The notable losers were Amazon.com Inc. (AMZN) -47% YTD and Tesla Inc. (TSLA) -48% YTD.
   3. Banks – The banking sector was dragged by the investment banking business being down significantly from the year-earlier level, with both mergers and acquisitions (M&A) and capital raising activities materially down. Citigroup Inc. (C) led the losers in the banking sector down 25% YTD, while peers Bank of America Corporation (BAC) and JPMorgan Chase & Co. (JPM) were down 25% and 16% YTD respectively.

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.