By Anu R. Ganti, Senior Director, Index Investment Strategy at S&P Dow Jones Indices (S&P DJI).
We frequently hear that “it’s a stock picker’s market.” The recent market environment could equally well be characterized as a sector picker’s market.
To measure the importance of sectors, we decompose total market dispersion into within-sector and cross-sector effects. Exhibit 1 shows that the contribution of cross-sector effects to total S&P 500® dispersion has trended upward this year, implying that the rewards for skillful sector selection have increased.
The recent travails of the banking industry have weakened the Financials sector, with the S&P 500 Financials down 4% YTD as of May 18, 2023. Meanwhile, the overall market has marched to a different drumbeat, with the S&P 500 up 10%. As Exhibit 2 illustrates, the Financials sector was the third-biggest detractor from S&P 500 performance, while Information Technology was the dominant contributor YTD.
As a result, investors who overweighted Information Technology or underweighted Financials would have been well rewarded, with the S&P 500 Ex-Financials up 12% YTD. However, it is worth noting that the outperformance of IT has been much greater than the underperformance of Financials, with the S&P 500 Information Technology up 28% YTD.
As sectors evolve over time, so does their diversification potential. As we previously explored for Energy and Information Technology, in Exhibit 3, we calculate the spread in trailing 12-month volatility between the S&P 500 and the S&P 500 Ex-Financials. When this spread is positive, the inclusion of Financials increases volatility in the benchmark; when negative, the sector acts as a diversifier. Note the negative spread for Financials so far this year.
The Financials sector has become a volatility diversifier because its correlation with the rest of the market has recently declined, as shown in Exhibit 4.
While the Financials sector has recently reduced volatility, this hasn’t always been the case. For example, during the depths of the 2008 Global Financial Crisis, the Financials sector was a major source of volatility. Despite the sector’s faltering relative performance so far this year, its current risk positioning might potentially prove auspicious for judicious sector allocators.
About the Author:
Anu R. Ganti is Senior Director, Index Investment Strategy at S&P Dow Jones Indices (S&P DJI). The index investment strategy team provides research and commentary on the entire S&P DJI product set, including U.S. and global equities, thematics, commodities, fixed income, and sustainability indices. She is also a frequent contributor to both print and broadcast media outlets.
Prior to joining S&P DJI, Anu worked in the asset management space, completing a post-MBA rotational program at Russell Investments within their fixed-income research and trading divisions and working as a portfolio manager focusing on emerging market equities at Parametric Portfolio Associates (a subsidiary of Eaton Vance).
Anu is a CFA charter holder and holds an MBA in finance and economics from Columbia Business School, and a bachelor’s degree in finance and marketing from NYU’s Stern School of Business.
