The financial landscape of 2023 has shown that predicting market behavior is an endeavor rife with challenge and complexity. Despite a palpable air of pessimism at the start of the year, the S&P 500® has surged nearly 20% by late July. From the low point in October, the gains look even more impressive.
Interestingly, this surge was not driven by a multitude of positive economic developments. Instead, it occurred amid a wave of negative news, including a contraction in tech-sector earnings, historically tight bank lending, and a decline in manufacturing. This paradox serves as a reminder to investors: Trusting one’s gut instinct may not always yield the best results, especially when market movements don’t necessarily reflect news headlines.
Drawing upon my research, I’ve dug into market history to unearth patterns and probabilities to aid in current outlooks. This exploration led me to three sectors—technology, consumer discretionary, and industrials—that show promising investing prospects amid these negative economic developments. Let’s take a closer look.
1. Tech Stocks: A Rally with Potential Staying Power
Despite negative news about tech-sector earnings, technology stocks have spearheaded the market’s rally this year. By late July, the sector was up more than 40% for the year. A closer examination of the sector’s historical data revealed an intriguing pattern. The market has an uncanny ability to anticipate earnings rebounds in tech, even when the sector’s earnings are falling.
Based on data since 1962, after 12-month periods when tech profits have decreased but tech stocks have outperformed, the sector’s earnings subsequently doubled over the next 12 months on average. Tech stocks also outperformed the broad market by an average of 7 percentage points during those periods.
Past performance can’t guarantee future results, but this pattern suggests that the tech rally might still have room to run, particularly if it’s been buoyed by anticipation of an earnings recovery.
2. Consumer Discretionary: A Sector with Bullish Trends
Consumer discretionary stocks, which comprise companies selling nonessential goods and services, may not seem like a lucrative investment during potential economic slowdowns. However, history begs to differ. Three trends are currently impacting this sector, all of which have historically been bullish.
Firstly, the sector’s price-to-book ratio relative to the broad market was recently in the bottom 25% of its historical relative valuation range. After trading at such low levels in the past, this sector outperformed the market by an average of 4 percentage points over the following 12 months.
Secondly, a steady decline in inflation since mid-2022 has effectively put more money in consumers’ pockets, which bodes well for companies selling nonessential goods and services. Historically, the consumer discretionary sector has outperformed the market 70% of the time during rolling 12-month periods when inflation was falling.
Lastly, despite the current tightness in bank lending, historically this has proven to be a contrarian buy signal. When bank willingness to lend hit the bottom 10% of its range in the past, consumer discretionary went on to beat the market more than 75% of the time over the next 12 months.
3. Industrials: A Current Slump that Could Predict Future Success
Much like consumer discretionary stocks, industrials currently present an attractive prospect. They are appearing relatively cheap, with the sector’s valuation relative to the broad market falling to the lowest 25% of its historical range, based on price-to-book ratios. This low relative valuation has historically been a positive sign for industrials: After bottom-quartile relative valuations, the sector outperformed the market over the next 12 months more than 70% of the time.
Manufacturing activity’s decline is largely responsible for the lower valuation of industrials. Despite this seeming like a cause for concern, history suggests otherwise. Following past instances when manufacturing activity was at comparably low levels, industrials had a more than 70% chance of outperforming the market over the following 12 months.
Although the current economic climate has its fair share of headwinds, these findings suggest that investors can remain positive—particularly regarding the technology, consumer discretionary, and industrials sectors. Remember, past performance doesn’t guarantee future results, but understanding historical trends and patterns can help inform and empower our investing decisions. As we navigate through the rest of 2023, it will be fascinating to observe how these sectors continue to perform and evolve.
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