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Q2 2020 sector scorecard

Upheaval spans Fidelity's latest scorecard across all sectors.

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The world has changed since Fidelity's last sector scorecard. COVID-19 upended essentially all aspects of sector investing over the short term—and the repercussions could reverberate for the remainder of 2020 and beyond. While US markets have rebounded dramatically from their lowest point of the year, the exogenous threat of coronavirus continues to linger above everything.

If you are reassessing the US stock allocation of your portfolio, this report finds that health care and technology scored the most positive marks, based on 3 key factors. Read on to see how the 11 US stock market sectors scored.

Scorecard: Investors moved toward tech and defensives

The economy likely entered recession in Q1, as efforts to address the coronavirus pandemic grounded economic activity. US stocks, as measured by the S&P 500, plunged from their February 19 peak, entering bear-market territory in record time (although they have recovered a significant amount of those losses over the past several weeks). Technology, health care, and consumer staples were the most resilient sectors during the first quarter, while energy and financials suffered the steepest declines. Our sector strategist believes cyclical sector exposure remains important if you anticipate a recovery.

Fundamentals: Technology, discretionary, and health care lead

The technology sector led our fundamental rankings, placing first in free-cash-flow (FCF) margin and second in return on equity (ROE). Consumer discretionary also fared well, with the market's best ROE and fourth-strongest EPS growth, while health care placed third on fundamental measures. Energy scored worst in 3 of the 4 metrics and second-to-last in the fourth.

Relative valuations: Financial stocks appeared inexpensive

Financials looked inexpensive at the end of the first quarter, with price-to-earnings and price-to-book values near the low end of the sector's historical range. Health care stocks also traded at low valuations compared with their history. By contrast, defensive sectors utilities and consumer staples looked relatively expensive, as did consumer discretionary.

Relative strength: Technology and health care on top

Strong first-quarter relative performance helped push technology, heath care, and communications services stocks into the top 3 spots in our relative strength rankings. Among the other sectors, energy, materials, and real estate exhibited relative weakness over the past 6 months.

A recession, bear market, and response unlike any other

The recession we likely entered in March has no real precedent or analog, as evidenced by the historic spike in unemployment claims. The government's response to replace lost income during COVID-19 mitigation efforts has been equally unprecedented. The Federal Reserve and Congress have injected monetary and fiscal stimulus equal to nearly 20% of US gross domestic product (GDP), compared to less than 1.5% in most recessions and 6.5% during the Global Financial Crisis.

In recession, stocks often don't follow earnings

During recessionary bear markets, stocks in aggregate tend not to follow earnings. In prior recessions, by the time earnings estimates fell 5%, stocks had suffered more than half of their bear-market losses. And while stocks bottomed an average of 70% of the way through prior recessions, the trough has come as early as halfway through recessions that were short and sharp. From the trough, the majority of the next 18 months of gains were often made before the end of the recession.

Recent investor fear has resembled the Global Financial Crisis

Fearful investors tend to sell stocks they believe are riskiest and buy those they see as safe, boosting the valuation spread between the market's most- and least-expensive stocks. Valuation spreads recently spiked to levels above the typical recession but lower than the Global Financial Crisis. The recent rotation from cyclicals to defensives has resembled 2008. In less than 30 days, the market priced in a level of fear that has usually taken a year to reach even during severe recessions.

Health care, staples, technology led during the downturn

Health care and consumer staples topped the market in the sell-off. Yet technology, long-considered economically sensitive, also has been resilient. Should investors sell these leading sectors and buy the laggards? Not necessarily. The wholesale change in sector leadership we saw following the Global Financial Crisis was unusual: In most cases, 1 to 3 sectors outperformed in the 6 months before, during, and after recessionary troughs.

Cyclical sectors often led following recession troughs

The sectors that have performed best from market lows tend to be similar from recession to recession. Economically sensitive sectors, notably financials and consumer discretionary, have had both high odds of outperforming the market and strong relative returns. Utilities, communication services, and energy have had some of the lowest odds of leading the market and the weakest relative returns from recessionary lows.

Equities may be attractively priced

Has the recent sharp decline made stock prices appealing? Historically, the equity risk premium (ERP) has been a useful guide. This metric subtracts the yield on the 10-year Treasury from earnings yield (company earnings divided by share price). The equity risk premium is currently in its cheapest quartile relative to history. In the past, stocks have advanced over the next 12 months more than 80% of the time from similar levels.

Health care stocks look healthy

The health care sector's free cash flow (FCF) has grown by nearly 50% over the past 12 months—double its historical average. The recent surge has pushed the sector's valuation as measured by FCF yield (FCF divided by company share prices) into the cheapest quintile of its historical range. When the health care sector's FCF yield reached comparable levels in the past, it outperformed the broad market almost three-quarters of the time over the following 12 months.

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