Don't get caught asleep at the wheel heading into the second half of the year. The small gain in the broader stock market so far this year hides more dramatic double-digit moves in some sectors. The key message from the first half of 2016 is this: Investors focusing solely on the broad market averages, like the S&P 500 or the Dow Jones Industrial Average, might be missing out on a bigger picture of stock market action.
Despite the early-year Chinese growth scare, crash in crude oil prices, and more recently the Brexit-inspired worries, at the midway point in 2016, the broader market is mostly unchanged. The S&P 500 shows a 2.7% gain through June 30. But digging deeper, a different picture arises if you look at individual sectors. Some posted double-digit gains, and others small losses.
|Information technology|| -1.2%|
Year-to-date returns through June 30, 2016.
Data source: S&P Global Market Intelligence
Sector Winners: It’s About Dividend Yields
Three of the biggest sector winners through the first half of 2016 were telecommunications services, utilities, and consumer staples. These are traditional "defensive" stock market sectors, or those that tend to outperform during weak economic periods or even bear markets. Pointing to the strong leadership of those three sectors, Sam Stovall, managing director at Global Market Intelligence, says, "Investors might conclude that the stock market is in the latter phase of a bull market and investors are preparing for a bear market."
But that's not the whole story.
Clue: It's all about yield. In today's era of historically low returns on bank CDs, money market accounts, and even U.S. Treasuries, income-starved investors typically turn to higher-yielding areas of the U.S. stock market.
"Those sectors have done well because they are the three sectors with the highest dividend yields," Stovall says. He notes that the telecommunications sector offers roughly a 4% dividend yield, while utilities is close to 3.5% and consumer staples a shade below 3.0%. Those all beat recent 10-year Treasury yields, which are hovering in the 1.40% range and have been falling in recent weeks.
Sector Laggards: Down Cycle for Cyclicals
Three of the weakest sectors in the first half of 2016 are so-called "cyclical" areas of the stock market, or those that tend to move up and down with the economic cycle. These include financials, information technology, and consumer discretionary.
"These sectors are closely tied to the undulating economic cycle. They tend to do well during the early and mid-phase of economic expansions and poorly during economic stagnation and contraction," Stovall says.
The year's worst performer is health care, which is a traditional "defensive" sector. But investor wariness in this sector relates primarily to political concerns, Stovall says. "Health care has outperformed the market for several years. But recently, both presidential candidates started talking about price caps on pharmaceuticals and biotech," Stovall says.
Stovall: Watch Health Care and Consumer Discretionary
Looking out into the second half of 2016, some investors may be tempted to jump aboard the winning sectors in a follow-the-leader fashion. Stovall, however, highlights potential for health care and consumer discretionary stocks in the months ahead.
The ingredients are in place to support a pickup in consumer spending. "Interest rates remain low, gas prices are relatively low, and employment trends are favorable at 4.7% unemployment. Wage growth at 2.4% exceeds the pace of inflation," Stovall says. "We believe the consumer discretionary group will be improving as we see a pickup in consumer spending," he adds. This sector includes auto companies, movies, entertainment, and online retailers.
Despite the political uncertainty that has weighed on the health care sector in the first half of the year, Stovall says the fundamentals remain strong. Also, the average price/earnings ratio is lower than the broader market at 15 for health care versus 17 for the overall market, he says.
Both health care and consumer discretionary stocks are expected to beat the overall market in earnings growth, Stovall says. In 2016, earnings per share for the S&P 500 is expected to decline slightly at -0.4%. However, he points to forecasts for solid earnings growth in health care at +6.7% and consumer discretionary at +12.6% for the year.
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