Anqi Dong discusses how to use dispersion and breadth to identify sector opportunities.
Sector investing is a powerful portfolio construction tool used to pursue alpha by capturing specific macro or industry trends more effectively than broad beta exposures can. Based on your investment thesis or process, sector investing may also include allocating to some of the subindustries within the broader sectors. Understanding when it may be beneficial to use a more granular industry exposure versus a broader sector can present challenges, however.
Performance trends can differ at the industry level and across sectors, something that’s happening in today’s market. The performance differential (i.e., dispersion) between the best-performing S&P 1500 industry versus the worst is 100%, compared with just 35% for S&P 500 sectors.1 In fact, wider dispersions at the industry level have been a persistent trend, as a larger opportunity set (69 GICS industries versus 11 GICS sectors) should naturally lead to higher return dispersion.
A greater opportunity set and high dispersion may provide investors abundant alpha-generation opportunities. However, in order to turn opportunities into profits, the selection process needs to land on the industry level winner, not the loser. As the leader in offering sector and industry investing solutions, we closely monitor sector breadth and dispersions among industries to identify areas with more alpha potential.
Using dispersion and breadth to identify opportunities
When assessing breadth and dispersion, we use S&P 1500 GICS level 3 industries, given their broad industry coverage.2 Sector breadth is measured by the percentage of industries in the same sector outperforming the broader market (i.e., S&P 500). This indicates the potential strength of the sector’s performance. If the sector breadth is widening, it means that common factors are lifting the overall sector and the strong sector performance is well supported — and not the result of one lone industry powering overall sector performance.
High industry dispersion reflects diverging return paths within the sector, warranting further research to identify if any industry-unique macro or fundamental trends are driving this behavior. We assess dispersion by using the interquartile range — the difference between the third and first quartile — of rolling three-month returns. The interquartile range helps reduce the impact of outliers driving the dispersion. Since industry dispersion for sectors with more underlying industries tends to be higher, as shown in the chart below, we measure dispersion relative to each sector’s history, using the percentile ranking of its current value over the past five years. Higher dispersion today relative to history will result in higher percentile ranking.
Charting out the opportunities
To understand where there may be opportunities, we divide sectors into four quadrants based on their breadth and dispersion:
The chart below shows sector dispersion plotted against breadth. Wide breadth in Consumer Discretionary, Industrials, and Materials indicates that the sector rallies are well supported. Dispersions in Consumer Discretionary, Materials, Industrials, Health Care, Technology, and Utilities are within the top decile of the past five years, pointing to more alpha opportunities at the industry level in these sectors.
By comparing current breadth and dispersion levels relative to the end of Q2, certain trends become more apparent:
As we get deeper into a profoundly uncertain 2020 — one that will feature an election and more communities seeking to fully reopen — return paths across and within sectors are likely to remain highly disperse. As identifying potential opportunities becomes increasingly important, our framework of dispersion and breadth may be a good research roadmap for making sector versus industry decisions.
To learn more about emerging sector investing opportunities, visit our dedicated sectors webpage.
1 Bloomberg Finance L.P., 3/23/2020 – 8/12/2020.
2 The analysis does not cover Real Estate and Energy due to the limited number of industries in the sector.
3 FactSet, as of 8/13/2020.
The information provided does not constitute investment advice and it should not be relied on as such. It should not be considered a solicitation to buy or an offer to sell a security. It does not take into account any investor’s particular investment objectives, strategies, tax status or investment horizon. You should consult your tax and financial advisor.
The views expressed in this material are the views of SPDR ETFs and SSGA Funds Research Team through the period ended August 18, 2019 and are subject to change based on market and other conditions and do not necessarily represent the views of State Street Global Advisors or any of its affiliates. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or
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