Identifying the best performing sectors can help investors in selecting the stocks that are most likely to outperform the overall market. In the following study, I have compared the performance of the different stock sectors in the last fourteen years. In addition to the returns by price appreciation, I also looked into the dividend contribution to the total returns and calculated the Sharpe ratio. The Sharpe ratio is a very important indicator to the reward to risk ratio. Following is the definition of "Sharpe Ratio" by Investopedia:
A ratio developed by Nobel laureate William F. Sharpe to measure risk-adjusted performance. The Sharpe ratio is calculated by subtracting the risk-free rate - such as that of the 10-year U.S. Treasury bond - from the rate of return for a portfolio and dividing the result by the standard deviation of the portfolio returns.
Obviously, past behavior is not necessarily expected to repeat itself in the future, but nevertheless, studying past performance helps us identify developing trends.
In order to compare the different sectors' performance, I used the SPDR ETFs corresponding to nine sectors, as shown in the table below.
Consumer Discretionary Select Sector SPDR Fund
Consumer Staples Select Sector SPDR Fund
Energy Select Sector SPDR Fund
Financial Select Sector SPDR Fund
Health Care Select Sector SPDR Fund
Industrials Select Sector SPDR Fund
Technology Select Sector SPDR Fund
Materials Select Sector SPDR Fund
Utilities Select Sector SPDR Fund
The table and charts below present the total returns and the Compound Annual Growth Rate (OTCPK:CAGR) between December 22, 1998 (first quote available for the SPDR Funds) and November 27, 2012 for the nine sector SPDR funds. The returns without dividends and with dividends are shown separately in order to emphasize the important role of the dividend yield. All funds' quotes and adjusted for dividends quotes were extracted from Yahoo Finance.
The table clearly shows that the energy sector has been the best performer in the last fourteen years with a total return with dividends of 265.30% (CAGR 9.74%), without the dividends the total return would be 201.29% (CAGR 8.24%). The second best sector has been the material sector, mainly because of the high dividend yield paid by the companies in the sector. Without dividends, the consumer discretionary sector has shown better appreciation with a total return of 78.98% (CAGR 4.27%); while the materials sector without dividend had a total return of 65.47% (CAGR 3.68%). However, with the dividend contribution, the total return of the materials sector was 115.89% (CAGR 5.68%), while the consumer discretionary sector had a total return of 103.53% (CAGR 5.23%). The last fourteen years have been disastrous to the information technology sector, which had a negative total return with dividends of -1.30% (CAGR -0.09%); and for the financial sector, which had a negative total return with dividends of -13.83% (CAGR -1.06%).
The table and the charts below present the Sharpe ratio for the nine stock sectors where the 30-year U.S. Treasury bond has been taken as the risk free rate in the Sharpe ratio calculations. I have also calculated the adjusted Sharpe ratio, in this case ignoring the risk free rate.
In general, the Sharpe ratio ranking was similar to the total return ranking, but the adjusted Sharpe ratio of the healthcare sector was better than the materials, the consumer discretionary and the industrials sectors, even that these three sectors had better total returns than the healthcare sector total return, due to lower volatility of the healthcare sector.
It is well known that the last fourteen years were not easy ones for investors in the stock market. The volatility has been very high, and we had two long severe bear markets, when the S&P 500 Index suffered a decline of 50.5% between its highest value on March 24, 2000 to its lowest value on October 31, 2002, and another decline of 57.7% between its highest value on October 31, 2007 to its lowest value on March 31, 2009. The total change in the S&P 500 Index during this period was only 16.2%.
Nevertheless, some sectors have behaved better than others; the energy and the materials sectors for the positive side, and the technology and the financial sectors for the negative side. Will this trend continue in the following years? It is yet difficult to tell, but investors should follow the behavior of the different sectors, in order to identify a change in the trend, and search for attractive stocks in the sector which is now in favor.