Sector Views: Monthly Stock Sector Outlook (2024)

Financials, Energy and Materials are rated Outperform, with all three benefiting from positive Value scores. Real Estatehas a low Value score and is currently rated Underperform, while Consumer Discretionary has dropped sharply recently in three of the five model components—Value, Growth and Sentiment—and is also rated Underperform. Although Information Technologyhas similar weakness in those three factors, its positive Quality score and relatively better growth prospects led us to override the model and we currently rate Information Technology as Marketperform.

Positives:Communication Services relies heavily on advertising and subscription-type revenue, which tends to rise when the economy is expanding.

Risks:The sector may underperform when economic growth slows, as was the case throughout 2022. A persistent risk is the dominance of bigger members, which command a large share of the sector's market cap and thus determine much of its performance.

Positives: Companies tend to be sensitive to economic activity, as consumers buy discretionary items more readily when job growth is strong and interest rates are low.

Risks: Concentration risk is high for the sector, with the two largest members accounting for nearly half of the total market cap The other half of the sector is also at risk of a worsening mix of risking input costs (particularly on the labor front) and falling demand.

Positives: Consumer Staples companies tend to be relatively insensitive to economic activity, as consumers buy staples regardless of economic conditions.

Risks: Companies can face shrinking profit margins in an inflationary environment without the pricing power to offset higher costs. Weaker earnings growth has made these stocks look expensive relative to the broader market.

Positives: Energy stocks are generally supported by improving oil prices. The sector has exhibited high-quality aspects given a relatively high interest coverage ratio—that is, companies are relatively well-positioned to pay interest due on outstanding debt—and a still-strong level of earnings.

Risks: Earnings growth might struggle if oil prices continue to fall on the heels of both relatively weak demand and a continued recovery in supply.

Positives: Some segments benefited from rising interest rates, which allow banks to lend at higher rates and insurance companies to increase returns on collected policyholder premiums. The economy has proven to be relatively resilient in the face of one of the most aggressive tightening cycles in history. Sector valuation is attractive.

Risks: It is still too soon to tell whether long and variable lags associated with monetary policy should be ignored, which means the economy is not yet out of the woods. With significant tightening in the pipeline amid the fallout from last year's banking issues, Financials' profits might take longer to rebound, which can weaken the earnings profile of the sector.

Positives: Health Care tends to do well even when economic growth slows, as most people will find a way to pay for necessary health care treatment even during tough economic times (although elective procedures often decline). It also can get a boost when heightened market volatility drives investors toward stabler choices.

Risks: Several companies in the sector (particularly in the biotechnology industry) have weak fundamentals. Downward pressure on earnings estimates is helping lift multiples—that is, stock price relative to earnings—especially for risky industries like biotechnology, which is a risk as interest rates stay elevated.

Positives: Industrials often benefit when economic growth raises business confidence, resulting in new building projects, machinery purchases, increased airline travel and shipments.

Risks: Industrials may underperform in the aftermath of rate-hike cycles as investors anticipate that higher inflation and borrowing costs can begin to undercut business and consumer spending.

Positives: Information Technology tends to do well when strong economic growth encourages companies to invest in technology upgrades and consumers to buy new devices. Some of the larger members are not in the "long-duration" camp—companies expected to produce their highest cash flows in the future—given they have current earnings growth and strong cash positions.

Risks: Many companies in the sector trade at higher multiples (price relative to earnings), and a rising-interest-rate environment puts downward pressure on valuations. Heavyweights in the sector are associated with the "stay-at-home" group that did well during the pandemic shutdown; they are currently facing pressure from the market's bias toward "average" stocks.

Positives: The Materials sector historically is sensitive to fluctuations in the global economy, the U.S. dollar, and inflationary pressures. In a less-severe recession, the sector's profitability might not take as large of a hit.

Risks: Stocks tend to underperform during rate-hike cycles as investors anticipate that higher inflation and borrowing costs will begin to undercut business and consumer spending. Materials relies heavily on foreign demand, and a stronger U.S. dollar tends to weaken sales abroad.

Positives: Real Estate, which consists primarily of commercial real estate investment trusts (REITs), tends to benefit from economic growth, which supports rent collections and property prices.

Risks: Most REITs borrow heavily, making them vulnerable to rising interest rates. The longer-term outlook for real estate is in question given uncertainty about a full post-COVID return to offices and major metro areas.

Positives: The Utilities sector has tended to perform relatively better when economic growth slows, as consumers usually cut spending on other items before they stop paying utility bills.

Risks:The sector is heavily indebted, especially relative to cash flow. Economic data have come in better than expected. The surge in Treasury yields can lessen the attractiveness of Utilities stocks, which tend to pay relatively high dividends, because investors can get similarly high yields elsewhere.

We begin with a data-driven evaluation of each of the 11 equity sectors based on five factors—Growth, Quality, Sentiment, Stability and Valuation. Multiple data points are used in this analysis, including estimated and historical dividend growth, cash flow, revenue per employee, price momentum, analyst price target revisions, sales growth variance, trading volume turnover, change in short interest, and forward price-to-earnings.

The sectors are then evaluated relative to the S&P 500 index to arrive at one of three preliminary ratings: Outperform, Marketperform and Underperform. Once confirmed, these ratings will reflect our view of how the sector is likely to perform relative to the S&P 500 during the coming six to 12 months.

The Schwab Center for Financial Research bases its approval on a combination of the quantitative model and a qualitative perspective on what's happening in the economy and markets. For example, there may be times when the model points toward a rating based on recent data, but SCFR's experts have strong reason to believe that an economic, market or geopolitical shift is underway that would change the sector outlook. In that case, SCFR may override the model.

Investors should generally be well-diversified across all stock market sectors. You can use the S&P 500 allocations to each sector, listed in the Sector Performance chart above, as a guideline.

Investors who want to make tactical shifts in their portfolios can use Schwab Sector Views' Outperform, Underperform and Marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab Sector Views can also be useful in identifying stocks by sector for potential purchase or sale.Schwab clients can log into their accounts and use Schwab's Portfolio Checkup tool to help assess their sector allocations. If they decide to make adjustments, they can use the Stock Screener to identify buy or sell candidates in particular sectors. Schwab's ETF Screener and Mutual Fund Screener also can help identify funds that specialize in particular sectors. Investors and clients should consider this as only a single factor in making their investment decision while considering the current market environment.