Sector investing is a powerful portfolio construction tool that may help deliver alpha by capturing more specific macro or fundamental trends than broad beta exposures can. Sector investing includes allocating to sub-sectors, or industries, given their larger opportunity set (74 GICS industries versus just 11 GICS sectors) and greater alpha potential.
As we near the end of the rate hike cycle, with the effects of monetary tightening working through various parts of the economy at different speeds, the return paths across and within sectors have become more divergent than usual, as shown in Figure 1.
That makes it more important to decide when and where to use a broad sector strategy and when to choose more granular industry exposures. Our breadth and dispersion four-quadrant framework can help you survey the sector universe to make better informed sector versus industry investment decisions.
We assess sector breadth and dispersion of sector moves with the S&P 1500 GICS level 3 industries, given their broad industry coverage.1
Sector breadth helps gauge the strength of sector moves. It’s measured by the 3-month average percentage of industries in the same sector outperforming the broader market (i.e., S&P Composite 1500® Index).
A good breadth indicates potential for strong sector performance. Widening sector breadth means that some common factors are lifting the overall sector and that strong sector performance is broadly supported — and not the result of just one industry powering sector performance.
High intra-sector dispersion supports alpha generation at the industry level, as it provides investors opportunities to generate high returns by owning leaders and avoiding losers. High dispersion reflects diverging return paths within the sector and warrants further research to identify if industry-specific macro or fundamental trends are driving this behavior.
Dispersion is assessed using the interquartile range — the difference between the third and first quartile — of rolling 3-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 Figure 2, we measure an industry’s dispersion relative to its own history with a 5-year percentile ranking of its current value. Higher dispersion today relative to history results in a higher percentile ranking.
To identify areas with more alpha potential, we divide sectors into four quadrants based on their breadth and dispersion.
Plotting current breadth against dispersion, the bright teal dots in Figure 3 show:
Figure 3: Plotting Breadth Against Dispersion, July 2023
Tracking sectors’ movement within the four quadrants compared to where they were three months ago illustrates two important underlying trends to inform your research and decision-making:
Technology, Utilities, Consumer Staples, Health Care, Real Estate, and Financials have moved from the right quadrants to the left ones. That means their intra-sector dispersion has tightened below the historical median over the past three months. Although Tech’s breadth remains high, the outperformance of some industry leaders — Software and Technology Hardware — has declined to lower single digits, resulting in low dispersion on the back of the waning relative strength of these two industry leaders.
Therefore, investors should be more cautious about Tech and watch for signs of further weakening. However, a lower dispersion driven by stronger relative strength of most underlying industries is a bullish sign for the sector.
On the other hand, Utilities, Consumer Staples, Health Care, Real Estate, and Financials have been sector laggards over the past three months. Their narrow breadth and lower dispersion indicate that bearish sentiment has spread across underlying industries within the sector.
While Communication Services continues outperforming the broad market, its narrower breadth driven by underperformance in Entertainment and Media industries, and continued weakness in Telecommunication Services, underscore the sector’s waning momentum.
But Communication Services, together with Industrials, Materials, and Consumer Discretionary, have shown higher dispersion, indicating industry performance leaders in these sectors, namely Interactive Media & Services, Airlines, Building Products, Construction Materials, and Automobiles, are bucking the sector trends and warrant more in-depth research.
Global Industry Classification Standard (GICS)
A financial industry guide for classifying industries that is used by investors around the world. The GICS structure consists of 11 sectors, 25 industry groups, 74 industries and 163 sub-industries, and Standard & Poor’s (S&P) has categorized all major public companies into the GICS framework.
S&P Composite 1500 Index
The S&P Composite 1500 Index is designed to measure the performance of the large-, mid-, and small-capitalization segments of the US equity market. The Index consists of those stocks included in the S&P 500® Index, the S&P MidCap 400® Index, and the S&P SmallCap 600® Index.
1 The analysis does not cover Energy due to limited number of industries in the sector.
The views expressed in this material are the views of the SPDR Research and Strategy team through the period ended August 10, 2023, and are subject to change based on market and other conditions. 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 developments may differ materially from those projected.
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.
All information is from SSGA unless otherwise noted and has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. There is no representation or warranty as to the current accuracy, reliability or completeness of, nor liability for, decisions based on such information and it should not be relied on as such.
Investing involves risk including the risk of loss of principal.
Equity securities may fluctuate in value and can decline significantly in response to the activities of individual companies and general market and economic conditions.
Because of their narrow focus, sector investing tends to be more volatile than investments that diversify across many sectors and companies.
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