Charles Schwab 2018 Mid-Year Outlook: Sector Volatility Expected to Continue
Halfway through 2018, the S&P 500® Index, which represents the broad U.S. stock market, had gained 2.7%—a relatively modest return that belied the drama of the first six months of the year. “Those of us who lived through it know the first half was anything but boring, and digging down a level illustrates that,” says Brad Sorensen, managing director of market and sector analysis for the Schwab Center for Financial Research.
Here’s how the 11 sectors in the S&P 500 stacked up YTD through June 30 in terms of total return:
Some sectors had a rough ride to an ultimately positive result. The energy sector, for example, which had a strong start to the year, took a steep dive before clawing its way back through a volatile spring. Others, like the consumer discretionary sector—the strongest performer of the period—benefited from the ongoing strength of the U.S. economy, rising throughout May and most of June.
Sectors experiencing first-half woes included consumer staples—which ended the period as the worst performer among the 11 sectors—and financials, which lost ground due to a combination of rising interest rates, a flattening yield curve and global trade concerns. “One way banks make money is to borrow at the short end and lend at the long end, earning the spread between the two,” Brad explains. “The short end of the curve has moved higher, while global trade concerns and the lack of global inflation appear to keeping the long end of the curve at least temporarily capped.”
Promising sectors for the second half of the year
In spite of recent troubles in financials, Schwab anticipates that a continued strong and growing economy will support this sector and other economically-sensitive sectors, such as technology. The Atlanta Fed GDPNow recently forecasted an annualized growth rate of 3.8% for Q2.
But there are risks; in fact, CNBC reported in late June that two-thirds of CFOs have expressed concerns that U.S. trade policies will hurt their companies over the next six months. If the implementation and threats of tariffs continue to escalate, there is an increased risk that capital expenditures will be postponed and merger-and-acquisition activity dampened—potential detriments to both financials and technology sectors. For now, though, both consumers and businesses remain optimistic.1
The health care sector may also outperform, providing some defense in an increasingly uncertain environment. The expectation of a more-accommodative FDA should allow for the approval of more prescription drugs, and continued consumer confidence could translate to Americans spending more on health care-related products and services. An aging population also bodes well for the sector. That said, political risk is ever-present, especially with midterm elections approaching. If the makeup of Congress changes markedly, we could see different regulatory or legislative moves affecting the health care sector.
Changes to the telecom sector are coming
The existing telecommunication services sector comprises just three stocks—AT&T, Verizon and CenturyLink. As the industry has consolidated over the years, the sector’s influence on the broader S&P 500 has waned. And not surprisingly, given its lack of diversification, the sector can swing wildly due to price movements of just one of those companies.
Last November, S&P Dow Jones Indices and MSCI Inc. jointly announced their intention to broaden the sector, which will be renamed communication services and will be rejiggered to include companies that facilitate communication and offer related content through various media channels. While the existing three companies in the current telecommunication sector will remain, others currently in the consumer discretionary and information technology sectors will move into this new sector, significantly changing its characteristics and, likely, its performance drivers and results. The changes are set to take effect in late September, so it’s something to keep in mind if you choose your investments based on sector.
Few people may be aware that an entire sector can contain as few as three stocks. The range between each sector is wide, as are their market-cap characteristics:
|Sector||Share of the S&P 500 Index||Number of constituent companies||Median constituent market cap (in millions)||Largest constituent market cap (in milllions)||Smallest constituent market cap (in millions)|
Source: S&P Dow Jones indices, as of June 29, 2018.
As we look ahead to the second half of 2018, here are a few things to keep in mind:
- While the first half of the year was a bit of a roller coaster ride, the second half may prove to be even more extreme, with bigger ups and downs.
- Staying diversified can help you manage the market’s inevitable volatility—particularly given its varying effects on individual sectors.
- Be aware of the composition of each sector, as well as forthcoming changes—such as the reconfiguring of the existing telecommunications sector to communications services— and how it could potentially impact your investments.
1Consumer Confidence Index, Dallas Fed Manufacturing Activity Index and Richmond Fed Manufacturing Activity Index, as of 07/02/2018.