The Investment Road Ahead
The second quarter ends this week. Next week, I will review the year-to-date sector performances. We may not yet be in a recession, but the sectors are performing in line with what we would expect during a transition into a recession.
For a recap of the business cycle approach to investing, see my recent article Positioning Your Portfolio for Higher Interest Rates.
The top sectors this year have been those that generally perform best in a recession: utilities, health care, consumer staples, and energy. The latter is historically a top performer leading up to a recession.
The worst performers year-to-date are consumer discretionary, technology and communication services. These are sectors that tend to perform poorly as the economy transitions into recession.
Searching for Value
The markets are always forward-looking. It may still be early, but if we start to look beyond the recession and into a recovery, it gives us some idea of which sectors might be the best values right now.
There are several sectors that historically do well in the recovery following a recession. The sectors that consistently outperform during this period are real estate, consumer discretionary, and industrials.
If we look at which sectors perform poorly in the late stage to recession period of the economy versus the ones that perform best in the recovery, we can get some idea of where we might think about bottom-fishing.
There are no sectors that go worst to first in the transition from the last stage of the economic cycle into a recession. But two sectors go worst to first in the transition from recession to recovery. Those are real estate and industrials.
However, the industrial sector has outperformed the S&P 500 year-to-date, and the real estate sector has performed in line with the S&P 500. So those don’t seem to be sectors that are ripe for bottom-fishing.
But if we broaden our search a bit, one sector does seem to be a good candidate for finding value, particularly if we have a longer time horizon. The consumer discretionary sector consistently performs worst in the late stage of the economy (which is technically where we still are), has inconsistent performance during a recession, and then consistently outperforms the market in a recovery.
That’s a mirror image of the energy sector, which outperforms in the late stage, is inconsistent during a recession, and then consistently underperforms during a recovery.
A Long-Term Strategy
Thus, a good long-term strategy based on the historical performance of the markets would be to shift some of those energy profits into the consumer discretionary sector. Year-to-date the energy sector is up 41%, and the consumer discretionary sector is in last place, down 28%.
You can get much more for your money in the consumer discretionary sector than you could have six months ago, especially if you are shifting money from the energy sector to do so.
What are some top-rated companies in the consumer discretionary sector? Currently, Fidelity rates 114 out of 815 companies in the sector to be either Bullish or Very Bullish. Those companies include mega-cap household names like Ford Motor Co. (NYSE: F), Lowe’s Companies (NYSE: LOW), and Dollar Tree (NSDQ: DLTR), and retailers like Macy’s (NYSE: M) and specialty services like H&R Block (NYSE: HRB).
Note that this shouldn’t be interpreted as a recommendation on any of these companies. There may be one or more factors that could eliminate them from consideration for your own portfolio, so you should always do your own due diligence.
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