The earth has seven continents, or so conventional geography says. Our solar system has nine planets (if you count Pluto, which is disputed). And all stocks fit into 11 categories, called sectors, as defined by Standard & Poor’s.
Classification is a useful but artificial process. When dinosaur fossils were discovered two centuries ago, scientists classified dinosaurs as reptiles. In so doing, they ignored certain characteristics that dinosaurs had in common with birds – three toes, for example.
The way we group things can subtly affect our perception of them. Scientists long believed that dinosaurs couldn’t be warm-blooded or fast-moving. After all, they were reptiles weren’t they?
In the world of investing, the 11 sectors identified by Standard & Poor’s influence investors’ thinking. Professional managers are keenly aware of their “sector weights.” Are they underweight financials? Are they overweight technology?
Here’s a look at some sectors that have been hot or cold lately.
Energy
Over the 12 months through Feb. 28, eight of the 11 sectors were down, and none was up as much as 3% -- except for energy, which had returned 23.6%.
Energy vastly outperformed other groups even though it has been one of the worst-performing groups lately, down 7.2% in the past three months. Investors face a stark choice. Should they pile into energy on the strength of the past year’s results, or flee it in light of its recent weakness?
It’s a difficult call, but I’m on the side of the energy bulls. Let’s start with the rig count – the number of working oil and gas wells in the U.S.
Back in 2014, before the oil-and-gas industry entered a terrible slide, there were about 1,900 active rigs. Today there are about 750, according to Baker Hughes.
In my book, fewer rigs means higher oil and gas prices. Add to that the effects of the Russian invasion of Ukraine, plus signs that some major shale-oil deposits in the U.S. are beginning to deplete. My conclusion is that for the next few years, the price of oil will be above $80 most of the time.
The energy stocks with the highest weights in the S&P 500 are Exxon Mobil Corp. (XOM, Financial), Chevron Corp. (CVX, Financial) and ConocoPhillips (COP, Financial).
Technology
Information technology stocks were the leaders of the U.S. stock market in the five years 2017 to 2021. They took an awful tumble in 2022.
What happened? The main problem was that, spurred by the Federal Reserve, interest rates rose. Rising interest rates have a harsh effect on the market’s more expensive stocks – those selling for a high multiple of recent earnings.
Following a miserable 2022, the tech sector has bounced back to life this year. In February it was the only sector with a gain – although to be sure it was a small gain, 0.4%.
Rising interest rates are still a threat. But the fact remains that the technology center is a beehive of innovation, and an area in which the U.S. leads the world. I think many tech stocks are buys now, and will be screaming buys if they decline further.
The technology stocks with the highest weights in the S&P 500 are Apple Inc. (AAPL, Financial), Microsoft Corp. (MSFT, Financial) and Amazon.com Inc. (AMZN, Financial).
Communication
The best-performing sector in the three months through February was communication services, up 4.1%. But it was the worst performer in the 12-month period, down 21.1%.
I wrote a column in October arguing that this sector had been treated too harshly in 2022. Perhaps in this case my timing was good.
The communication services stocks most heavily weighted in the S&P 500 are Alphabet Inc. (GOOGL, Financial), Walt Disney Co. (DIS, Financial) and Comcast Corp. (CMCSA, Financial).
Health care
The booby prize for the worst three-month performance goes to the health care sector, down 8.2% from December through February. This puzzles and disappoints me, since I had added to my clients’ health care holdings as the chance of a U.S. recession appeared to me to rise.
Health care stocks – and drug makers in particular – have traditionally been a haven in down markets. Much spending on health care is non-discretionary.
The recent weakness in health-care stocks might mean that they have lost their traditional defensive character, or that there won’t be a U.S. recession in 2023. Then again, it could also be the case that the sector got a boost from the Covid pandemic, and that this boost is now fading.
The biggest stocks in the S&P’s health care sector are United Health Group Inc. (UNH, Financial), Johnson & Johnson (JNJ, Financial) and AbbVie Inc. (ABBV, Financial).
John Dorfman is chairman of Dorfman Value Investments LLC in Boston, Massachusetts. He or his clients may own or trade securities discussed in this column. He can be reached at [email protected].
