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Q4 sector scorecard: after the upheaval

Global markets were roiled last quarter, but the sector outlook remains mostly consistent.

  • Fidelity Asset Management
  • – 10/21/2015
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How did the summer selloff impact the sector outlook? Not too drastically, it appears. Fidelity's latest Quarterly Sector Update shows technology, health care, and consumer discretionary stocks remain best-positioned among the 10 sectors. Keep reading or watch the video (see right) to find out why.

What is Fidelity’s Quarterly Sector Update?

The Quarterly Sector Update, including the Sector Scorecard, represents input from three discrete Fidelity investment teams—each with unique insights about sector investing—to present a comprehensive view of the performance potential of the 10 major equity market sectors. The Sector Scorecard’s proprietary methodology measures the relative attractiveness of each sector against five key factors: business cycle, fundamentals, relative valuations, momentum, and relative strength.

Scorecard: Positives for tech, health, consumer discretionary

Despite a negative Q3 for nine of 10 sectors, technology fundamentals remain solid and valuations are attractive. Consumer discretionary weathered the recent volatility better than most and still has a positive return on a year-to-date basis, but valuations are relatively high. Health care fundamentals have been persistently strong, but like discretionary, valuations are high relative to other sectors.

Industries: Top five and bottom five performers this quarter

In Q3 2015, only 12 of the 67 industries that comprise the MSCI USA Investable Market Index (IMI) were positive on a total return basis. The energy, health care, and telecom sectors had no industries with positive returns during the quarter. Four of the five industries within the utilities sector had gains, helping utilities to be the only sector to generate a positive return in Q3.

Business cycle: U.S. economy remains solidly mid-cycle

The U.S. economy remains in a mid-cycle expansion, which historically has supported the performance of the information technology and industrials sectors. While energy typically exhibits no clear relative performance pattern in mid-cycles, the muted oil price outlook amid the continued excess of supply versus demand is likely to remain a headwind for the sector.

Fundamentals: Technology, health care remain on top

From a fundamentals viewpoint, tech and health care ranked highest over the past year. Tech was boosted by strength in free cash flow and earnings per share. Heath care fundamentals also continued to be strong, though not necessarily improving. Energy fundamentals weakened the most amid persistently low oil prices and adverse supply-demand conditions.

Relative valuations: Technology, financials appear inexpensive

Financials and technology are among the least expensive sectors, and materials is also relatively cheap due to weakness in metals & mining. In comparison, valuations for the three sectors with the highest year-to-date returns—consumer discretionary, health care, and consumer staples—are higher but not unreasonable relative to other sectors.

Momentum: Health care, both consumer sectors highest

Despite recent declines, health care and consumer discretionary momentum was still highest, along with consumer staples, which benefited from its defensive nature amid the global volatility in Q3. Energy remained the biggest laggard, due to slowing demand from China and low oil prices. Materials’ momentum turned negative after falling roughly 17% in Q3.

Relative strength: Discretionary, staples, utilities, and tech

Consumer discretionary has been positive during the past year. Consumer staples and utilities both spiked higher in Q3, and technology sustained its strong multiyear trend. On the other hand, health care suffered a sharp correction after an extended period of strength, while energy and materials continued along their negative trajectory.

Slow rebalancing keeps outlook for oil prices muted

The sharp drop in oil prices during the past year has finally begun to stimulate global demand. However, global supply growth continues to outpace demand growth, which implies large global inventories have yet to be reduced. A greater demand response from China and other emerging markets is likely needed to generate a sustainable increase in oil prices.

Energy sector sending mixed signals

On a price-to-book (P/B) basis, the energy sector is the cheapest it has been in 50 years, and the sector’s dividend yield is at its highest level in 20 years. But at the same time, the energy sector’s relative price-to-earnings (P/E) is at its highest level in 15 years as lower oil prices have reduced earnings, and prior increases in capex spending have also hindered free cash flow (FCF). So while certain valuation metrics look attractive, fundamentals in the sector remain challenged—presenting an unclear picture for investors.

Effect of volatility in China and other EMs on U.S. sectors

A weakening outlook for emerging markets was a headwind in Q3 for sectors such as energy and materials. Historically, weaker economic growth in emerging markets has coincided with the outperformance of defensive sectors such as utilities, health care, and consumer staples, and weakness for more economically sensitive sectors such as technology.

Sector investing can significantly reduce company-specific risk

The diversification benefits of sectors can greatly reduce portfolio volatility compared to single-stock U.S. equity ownership. There is also a significant reduction in downside risk when investing in sectors. This can help individuals weather bouts of volatility while staying invested, and can also lessen the subsequent gain required to catch up after a loss.

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Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the authors and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.
References to specific investment themes are for illustrative purposes only and should not be construed as recommendations or investment advice. Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.
This piece may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
Past performance is no guarantee of future results.
Investing involves risk, including risk of loss.
All indices are unmanaged. You cannot invest directly in an index.
Stock markets are volatile and can decline significantly in response to adverse issuer, political, regulatory, market, or economic developments.
Because of its narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies. Sector investing is also subject to the additional risks associated with its particular industry.
Market Indices
The S&P 500® Index is a market capitalization–weighted index of 500 common stocks chosen for market size, liquidity, and industry group representation to represent U.S. equity performance. S&P 500 is a registered service mark of Standard & Poor’s Financial Services LLC. Sectors and industries are defined by the Global Industry Classification Standard (GICS).
The S&P 500 Sector Indices include the standard GICS sectors that make up the S&P 500 Index. The market capitalization of all S&P 500 Sector Indices together composes the market capitalization of the parent S&P 500 Index; each member of the S&P 500 Index is assigned to one (and only one) sector.
Sectors are defined as follows: Consumer discretionary: companies that provide goods and services that people want but don’t necessarily need, such as televisions, cars, and sporting goods; these businesses tend to be the most sensitive to economic cycles. Consumer staples: companies that provide goods and services that people use on a daily basis, like food, household products, and personal-care products; these businesses tend to be less sensitive to economic cycles. Energy: companies whose businesses are dominated by either of the following activities: the construction or provision of oil rigs, drilling equipment, or other energy-related services and equipment, including seismic data collection; or the exploration, production, marketing, refining, and/or transportation of oil and gas products, coal, and consumable fuels. Financials: companies involved in activities such as banking, consumer finance, investment banking and brokerage, asset management, insurance and investments, and real estate, including REITs. Health care: companies in two main industry groups: health care equipment suppliers and manufacturers, and providers of health care services; and companies involved in the research, development, production, and marketing of pharmaceuticals and biotechnology products. Industrials: companies whose businesses manufacture and distribute capital goods, provide commercial services and supplies, or provide transportation services. Technology: companies in technology software and services and technology hardware and equipment. Materials: companies that are engaged in a wide range of commodity-related manufacturing. Telecommunication services: companies that provide communications services primarily through fixed-line, cellular, wireless, high bandwidth, and/or fiber-optic cable networks. Utilities: companies considered to be electric, gas, or water utilities, or companies that operate as independent producers and/or distributors of power.
Third-party marks are the property of their respective owners; all other marks are the property of FMR LLC.

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