Risk Adjusted Sector ETF Performance: 3rd Quarter Update
Analysts often compare sectors for clues about the economy’s performance and future investments. The performance of these sectors must be adjusted for beta, or risk. What does this 2rd quarter adjusted performance tell us? Seeking Alpha readers know that I periodically analyze the performance of the nine S&P 500 sector ETFs to obtain clues about where the economy is going. Last years’ underperformance by the Materials Select Sector SPDR ETF (NYSEARCA: XLB ) was only the beginning of a very bad year (so far!) for those stocks. In contrast, after adjusting for risk, Consumer Discretionary (NYSEARCA: XLY ) stocks performed well late last year: and that outperformance has continued. (You can see the article on which this analysis is based here .) The most recent quarter was unpleasant for common stocks: so while all nine sectors fell, we must adjust this poor performance for the varying risk profiles of each sector before we compare it to the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). An illustration of how this is done will help, and point out a major red flag for the market going forward. Investors know that the healthcare sector has been one of the leaders in this bull market since it began in 2009. In the last three months the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ) fell 12%, two and a half percentage points more than the 9.5% for SPY. So yes, the market has lost some of its leadership: always a source of worry for bulls. But after adjusting for risk, the situation is even worse than it looks! According to yahoo finance XLV has a beta of .59; in a down market we should expect it to fall less than the broad indices. Not more! Specifically we should expect it to fall only 5.6%: (S&P 500 change) x (Sector ETF beta) = (expected risk adjusted ETF return) so (-9.5%) x (.59) = (-5.6%) So the healthcare sector underperformed, not by 2.5%, but by 5.6%! The full results are shown below. You can see that along with healthcare, energy (NYSEARCA: XLE ) and basic materials performed much worse than the market in the last few months. Risk Adjusted ETF Performance 3rd Quarter 2015 Select Sector SPDR ETF beta Actual Return Expected Return +/- Discretionary .91 -3.0 -8.7 +5.7 Technology (NYSEARCA: XLK ) 1.35 -9.1 -12.8 +3.7 Industrials (NYSEARCA: XLI ) 1.00 -11.0 -9.5 -1.5 Basic Materials 1.13 -21.0 -10.7 -10.3 Energy 1.02 -22.0 -9.7 -12.3 Staples (NYSEARCA: XLP ) .49 -3.5 -4.7 +1.2 Health Care .59 -12.0 -5.6 -6.4 Utilities (NYSEARCA: XLU ) .44 -3.0 -4.2 +1.2 Finance (NYSEARCA: XLF ) 1.19 -8.0 -11.3 +3.3 S&P 500 Index 1.00 -9.5 -9.5 zero All three underperformers can turn to special situations as an explanation: Healthcare? Hillary Clinton’s drug company bashing . Energy? The continued weakness in oil and natural gas prices. Basic materials? Continued weakness in Asia , especially China. Even given the dour economic news in these sectors, investors should remember their underperformance signals that this bad news has signaled the market has still not completely discounted this poor outlook. Focusing on healthcare in particular, the failure of this sector’s leadership has ominous signals for the market going forward. While some market indexes have signaled a bear market is now in progress–an issue I shall address in an article tomorrow– I am willing to give the market a bit of slack here. Why? Notice the strength in consumer discretionary stocks. This suggests families are benefiting from lower energy prices: a case of one good cancels out the bad, perhaps? The strength in tech is encouraging. Surprisingly the best indication might be the belated showing of the financial stocks. Remember: this whole debacle began years ago in the financial sector! For them to perform well in a weak market which still may face an interest rate increase from the FED , is encouraging. Keep your long and short powder dry until the market gives us clearer signals. More on this in my next article.