A sector represents a high-level way in which analysts and investors group similar companies together. Analyzing Standard & Poor’s Depositary Receipts (SPDRs) serves as one of the best proxies to determine the best-performing areas of the economy. Below is a performance summary of the nine sectors it tracked for the period ended Dec. 31, 2013:
TOTAL SECTOR RETURNS as of 12/31/2013
Source: State Street Global Advisors
The above list starts with the best performer (consumer discretionary) for 2013 and works its way down to the worst performer (utilities). Very generally, the strong stock market performance for the year (the S&P 500 returned better than 30% including dividends) was attributed to a robust recovery from the Great Recession, government regulations (such as Obamacare health exchanges even though they weren't fully implemented) and investor beliefs that the worst of the credit crisis had finally passed. Another factor was the U.S. economy's strength versus international markets, including European struggles due to high unemployment and slowing growth in Asia (China).
The Best Sector Performers
Below is an overview of the top-performing sectors for the year and more specific reasons for their strength.
The consumer discretionary sector contains industries and firms that are heavily influenced by ups and downs in the economy. Because the goods are of a discretionary nature, consumers want them but don’t need to have them if money becomes tight. This space performed well because of expectations that the economy is moving from recovery into expansion mode. Increasingly higher consumer confidence over the course of the year led to higher sales in automobiles, travel and luxury goods. Stock valuations also started the year quite reasonably, which helped contribute to the strong sector performance for 2013. (Source: click here.)
The health-care space is relative easy to understand. Key industries include hospitals, pharmaceutical and biotechnology companies, as well as drug and equipment retailers and distributors. Positive biotechnology developments, including Google's decision to found Calico to develop therapeutic solutions to combat aging, have helped drive the entire sector forward as investors bid up the shares of companies with positive drug development news. In terms of government regulation, the Affordable Care Act passed in 2010, and a Supreme Court decision in October 2012 upheld most of its key components. As such, 2013 marked a year where the market began to move forward as opposed to fighting the Act’s overall existence. In other words, health care started returning to its steadier historical performance that operates somewhat independent of the economic cycle. (Sources: here and here.)
As dry as it sounds, the industrial sector consists of companies that make and distribute capital goods. Examples include airplanes and related components, industrial machinery and engineering know-how. As with consumer discretionary names, the economic recovery helped boost the operations of industrial firms. The largest firms, including General Electric and United Technologies, also benefited from cost cutting and belt tightening during the Great Recession. Additionally, investor enthusiasm for fracking and energy independence grew. Industrial firms are planning to expand into oil and gas extraction in large shale resource areas in Texas, North Dakota and Pennsylvania. (Source: here.)
Financial firms operate in the banking industries, consumer and commercial finance, and asset management, just to name a few. The key components behind the finance sector's strength during 2013 were historically low valuations and improving fundamentals. Pessimism remained as some of the large players including Bear Stearns, Lehman Brothers and Washington Mutual literally disappeared during the credit crisis. But the competitive environment has favored those that survived and include Morgan Stanley, Citigroup and JPMorgan Chase. Again on the regulation front, the Dodd Frank Act, passed in 2010, had let financial firms adjust to the sweeping reforms by 2013. At this point, many of the related regulations are in place. (Sources: here and here.)
The consumer staple sector is a mirror opposite to the consumer discretionary space. Firms in this sector are much less sensitive to the business cycle and economic ups and downs. Food companies are a prime example, with tobacco and personal products other well-known areas. Kraft Foods, Procter & Gamble (NYSE: PG) and Altria Brands (NYSE:MO) are some of the larger players in the space. In contrast to the other sectors, valuations weren’t low at all during 2013. Instead, investors remained committed to more stable firms and sought their above-average dividend yields in the face of historically low interest rates.
Predictions for 2014
For the coming year, the high valuations and expectations for higher interest rates put the continued strong performance of consumer staples space at risk. Consumer discretionary stocks should still perform as long as the economy continues to improve. Financial valuations still look quite reasonable, and there will be plenty of health-care winners from the changes being brought about by the Affordable Care Act.
The best way to consider investing in the above sectors (especially the ones that continue to have favorable prospects going forward) is to invest in some of the largest and safest individual companies in each space. Investors could start by identifying their favorite industries, then honing in further on the companies with the best growth prospects that also might be trading at reasonable valuations.