Q3 2020 sector scorecard

Technology leads Fidelity's latest sector scorecard.

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Since Fidelity's last sector scorecard in April, a lot has changed, yet much remains the same. COVID-19 continues to dominate the news as states struggle to reopen amid a resurgence in cases. Find out how the 11 US stock market sectors fared in Fidelity's sector scorecard, followed by additional insights from sector strategist, Denise Chisholm.

Scorecard: Investors continue to emphasize tech

The US equity market during the second quarter regained much of the ground it lost in February and March, driven by massive government stimulus and an improving economic outlook. Consumer discretionary, information technology, and energy were the best-performing sectors during the quarter, while utilities and consumer staples fared worst. Our sector strategist thinks consumer discretionary and energy may continue to outperform.

Fundamentals: Tech, communications, and health care led

Heading into the third quarter, the technology sector led the fundamental rankings as shown in the scorecard above, with the highest return on equity (ROE) and free-cash-flow margin (FCF). Communication services and health care also fared well, with reasonably high FCF margins and earnings-per-share (EPS) growth. Energy lagged far behind the other sectors by fundamental measures, scoring poorly on all 4 metrics.

Relative valuations: Financials remain inexpensive

The energy sector remains the least expensive on asset-based measures, but is still mixed on earnings and free cash flow relative to the sector's historical range. Financial stocks also looked inexpensive, with the second-lowest relative price-to-earnings and price-to-book ratios. Consumer discretionary and utilities looked relatively expensive.

Relative strength: Technology and health care on top

Strong 6-month relative performance pushed the technology, consumer discretionary, and health care sectors into the top 3 spots in our relative strength rankings. Energy, financials, and industrials ranked lowest as of the end of the second quarter.

Disparities may support market gains

The gap between the valuations of the most- and least-expensive stocks tends to widen during times of market turmoil. That pattern held earlier this year, as valuation spreads jumped when the market dropped in February and March. Stocks subsequently rallied—but valuation spreads stayed high. When valuation spreads have been at comparable levels in the past, the market has returned an average of 18% over the following 12 months.

Not the typical recession for spending

In typical recessions, most laid-off workers don’t expect to get their jobs back. This time’s different: As of May, roughly three-quarters of workers thought they'd be rehired. In another departure from previous recessions, bank lending to businesses has jumped, in part reflecting the use of the Paycheck Protection Program. Both trends suggest spending power could hold up better than in previous recessions.

High savings rate may boost consumer firepower

The personal savings rate climbed into the teens in March and then spiked to 33% in April. The extreme increase resulted from a combination of government stimulus, which injected cash into consumers' accounts, and lockdowns, which prevented them from spending it. Consumers’ cash hordes potentially give them greater spending power than in past recessions. Historically, top-quartile savings rates have fueled strong consumption growth.

The recession might be short-lived

The National Bureau of Economic Research (NBER) has announced that a recession officially began in February. How long will it last? NBER defines the end of a recession in part as the trough in job losses, and both hiring and retail sales improved considerably in May after plummeting in April. If recent gains continue, the recession may be nearing its official end—which would make it one of the shortest on record.

If recession ends, stocks likely to advance

There were 14 recessions in the 90 years through 2019. The stock market advanced during the 6-month periods following each one. Moreover, stocks gained an average of 80% from the recessions’ end through the market's recovery. The upshot: Forgoing stocks at this point risks leaving potential return on the table. During recoveries, cyclicals likely outperform.

A contrarian case for energy

Energy demand collapsed earlier this year. Counterintuitively, drops in energy demand have presented buying opportunities in energy stocks: The energy sector has outperformed the broad market in most 12-month periods following year-over-year demand declines. The odds have been even stronger after demand started to rebound, especially following times that energy had led the market down into recession—and both situations apply now.

Rising inventories may not drown energy stocks

The bear case on energy holds that energy stocks' valuations could suffer as weak demand leads to rising inventories, which in turn pressure energy prices. It's true that lower demand typically has led to rising inventories. But more often than not, energy sector stock valuations have actually risen during the 12 months following drops in energy demand.

Consumers' dry powder could fire up consumer discretionary

Historically, a jump in the personal savings rate has been especially supportive of consumer discretionary stocks. The rate recently reached its highest level on record. After periods in which the personal savings rate has been in the top quartile of its historical range, consumer discretionary has outperformed the broad market by 2.4%, on average, during the next 12 months.

Lending cycle also may favor consumer discretionary

Banks may be lending more to businesses, but they've become less willing to lend to consumers. Does bankers' reluctance to lend to households undermine the case for consumer discretionary? History suggests that the answer, surprisingly, may be no: After big declines in banks' willingness to lend to consumers, consumer discretionary has been the sector most likely to outperform. The explanation may be that lending tends to be cyclical, so rebounds in lending may have helped power greater spending.

Next steps to consider

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She uses history to share probability analysis on the US equity sectors.

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