The stock market is a living, breathing organism that changes its nature constantly. Day to day, global events can trigger large, temporary buying or selling activities by investors, making it difficult to predict stock moves. Short-term movements can rattle even the most experienced investors, but those who keep a long-term view know that the market does present a kind of predictable behavior.
The economy typically follows a path known as the business cycle. As the economy ebbs and wanes, different sectors find themselves in and out of popularity. It’s broken down into four separate phases: early, middle, late and recession. Knowing what stage the economy is in can often help you understand what sectors will do well and what sectors will underperform.
Where the Economy Is Today
The stock market is hovering near all-time highs, so it would be natural to assume that we’re currently in the late-stage cycle of economic growth. We’ve hit the top and, based on the lethargic data coming in — such as the Fed’s estimate of just 0.01% GDP growth for the first quarter — a recession phase could be just around the corner. If so, we should see energy and materials leading the way down, while defensive sectors such as utilities and consumer staples start rising as investors begin preparing for the downturn.
And that’s exactly what we see right now. The top three best performing sectors YTD are utilities, energy and materials, which is right in line with what we’d expect to see in the late-stage cycle of economic growth. On top of that, the Fed has started raising interest rates with another hike expected at least once this year — a sign that the Fed believes this market still has room left to run for the foreseeable future.
As the economy hits its peak, investors begin to seek shelter in defensive sectors ahead of the inevitable pullback. Year-to-date, the utilities sector is the best performer, up about 17%. Interested investors might want to take a look at American Century Utilities Fund (BULIX). Up around 15% this year with an expense ratio of just 0.67%, this fund is a bargain in defensive investing.
The energy sector is finally making a comeback this year as oil begins to stabilize. Oil prices have struggled for more than two years now, and the energy trade has been one of the most disappointing. But now this sector is undervalued and making investors significant gains this year. Vanguard Energy Fund (VGENX) is up over 18% year-to-date, and its incredibly low expense ratio of 0.37% makes it very fee-friendly.
The materials sector is a welcome surprise this year considering the difficult environment with commodity values. The uncertainty of equities earlier in the year along with rising volatility gave way to a precious metals bull run with silver and gold leading the way. Even some industrial metals, such as steel and copper, have begun seeing gains this year. Fidelity Select Materials Portfolio Fund (FSDPX) is the best way to get access to this sector. It’s up around 5% year-to-date, comes with a 0.81% expense ratio and carries lower relative risk in its portfolio compared with other materials funds.
As we head into the middle of 2016, it’s likely we’ll see defensive sectors continue to outperform. Utilities and consumer staples should lead all other sectors, and health care should see significant gains as well. Undervalued sectors such as energy will continue to mount a comeback, as oil slowly rises to the upper-$40 to low-$50 range, and materials should pick up the pace after the summer lull.
Other defensive sectors, such as health care and consumer staples, should do well going forward and may even take over energy and materials as the highest gaining sector of the year. Financial stocks could see some gains as well if the Fed raises rates again sooner than expected, but they will face headwinds from leveraged loans in the energy space. As usual, the Fed has the reins in this market and will ultimately decide what sectors will outperform this year.