The Fed's QE3 stimulus program is scheduled to finally come to an end in November 2014 after an extended period of tapering. Recent history suggests that this does not bode well for the U.S. stock market, which has struggled when standing naked without the crutch of Fed stimulus in the post crisis period. But not all stocks are created equally. For while many stock sectors certainly trailed along with the broader market without the steady flood of liquidity from the Fed, a select few demonstrated the ability to hold up well. Some even showed the ability to achieve solid gains. And while history may not necessarily repeat itself the next time around, these previously winning sectors may warrant some extra attention as QE3 draws to a close and we streak toward 2015.
Revisiting a perspective first introduced in a previous article, the U.S. stock market has had to endure only 129 trading days in the post crisis period without any support from the Fed. This includes the periods without outright quantitative easing, without Operation Twist, and without any blatant signals from the Fed that a fresh round of stimulus would soon be on its way. The trading days considered for this analysis occurred first from April 1 to August 26, 2010 and then from July 1 to August 8, 2011. This perspective is deemed relevant given the fact that the Fed seems intent with the winding down of QE3 to exit any further asset purchase programs and turn its policy focus elsewhere.
Several sectors have shown the propensity to struggle mightily without the comforting shroud of Fed liquidity. Leading among these not surprisingly is the financials sector (NYSEARCA:XLF), which was shocked back to life with the Fed equivalent of emergency defibrillators during the depths of the crisis. Sure, the banks are still alive and are back on their feet in most cases, but the sector is far from what could be described as fit and healthy. The financials have struggled at times with continuous Fed support, and they have done far worse without it.
Of course, the financials sector has not been alone in suffering without Fed support.
Not surprisingly, some of the other sectors hail from the more cyclical areas of the market. Leading among these to the downside is the materials sector (NYSEARCA:XLB), which has consistently underperformed the broader market by anywhere between -1% to -5% throughout the cumulative non-stimulus periods.
The industrials sector (NYSEARCA:XLI) has also been mixed at best relative to the broader market. While it has had stints of relative outperformance, it has also endured periods of trailing results, particularly at times when stocks were accelerating to the downside. What may work against industrials in the future, however, is that they have significantly outperformed the broader market during the QE3 period. Given that the sector is historically very tightly correlated to the S&P 500 (NYSEARCA:SPY), this recent double-digit cumulative outperformance has the potential to be given back in a jarring way for those that are allocated to the sector.
The last of the leading sector losers is perhaps also the most surprising. The health care sector (NYSEARCA:XLV) has also shown itself to be a chronic underperformer relative to the broader market by a consistently meaningful margin during non-stimulus periods. This trailing performance is notable given the fact that the health care sector is generally regarded as among the more defensive and less volatile areas of the market that typically provide a benefit during periods of broader stock market declines. Such has not been the case in the post crisis period when the Fed has stood down from providing support.
A number of other sectors have demonstrated the tendency to simply track along with the market in a narrowly oscillating pattern of relative performance.
The first among these is the energy sector (NYSEARCA:XLE), which has traded in a tight performance band relative to the S&P 500 Index during non-stimulus periods.
The same can be said of the technology sector (NYSEARCA:XLK), although it should be noted that tech shares exhibited slightly better marginal results relative to its oil and gas counterparts.
But perhaps the most surprising tracking sector is also the one that has performed the best of the three trackers on a relative basis. This is the consumer discretionary sector (NYSEARCA:XLY) that includes economically sensitive industries such as retail, consumer durables, automobiles and media. While many stocks in the sector were sold off brutally during the financial crisis, they have shown the ability to consistently outperform both during stimulus and non-stimulus phases throughout the post crisis period. The sector may be very hard pressed to continue this relative outperformance going forward, however, particularly if the recent performance of the retail sector is any guide of what is to come.
A select set of sectors have demonstrated the ability to achieve strong relative results relative to the broader market during periods without the support of Fed stimulus. They have done so in most cases with considerably lower price volatility and have even shown the ability to generate solid gains in the midst of these more challenging conditions.
The best performer during non-stimulus periods has been the utilities sector (NYSEARCA:XLU). Not only has it been able to generate steady gains while the broader market has moved lower during these periods, but it has managed to increasingly widen its relative performance advantage the longer these non-stimulus periods continue.
Looking forward, the utilities sector is exhibiting the ability to potentially deliver strong relative results once again when QE3 draws to a close. Given that utilities have trailed during periods when the Fed is applying stimulus, it is still working to close the relative performance gap versus the broader market. Perhaps more notably, the utilities sector has been trading with a weekly returns correlation to the broader market that is a remarkably low +0.09. Normally this reading is in the +0.70 range. In other words, utilities are providing a real positive diversification to investors at a time when they need it most.
Another sector that is also included among the winners during non-stimulus periods is perhaps the most expected in the consumer staples sector (NYSEARCA:XLP). One concern for investors in these more defensive food and household product companies is that they have performed increasingly well relative to the broader market since the outbreak of the financial crisis back in 2007. As a result, some are now trading at peak valuations and may warrant a degree of caution and a little extra inspection before locking in any commitments. But their relative performance in recent years during periods without Fed support is still notable.
The last winner is a special case but one that warrants its own category for the purpose of this analysis. REITs (NYSEARCA:VNQ) are technically part of the financials sector. But their characteristics are sufficiently unique and performance is notably differentiated that they are worth a closer look on their own. And much like the utilities sector, the industry has been a notable outperformer relative to the broader market during non-stimulus periods. With the exception of periods defined by extreme and sharp stress such as the stretch in early August 2011, the real estate industry (NYSEARCA:IYR) has been a consistently strong market leader that has shown the ability to generate solid gains at times when the broader market is without Fed stimulus support.
And also like the utilities sector, the real estate industry remains in the process of gradually closing a relative performance gap that had been opened starting last May and June when REITs broke sharply and sustainably lower while the broader market bounced back in the second half of the year. As a result, the real estate sector is one of the few areas of the market at the moment presenting reasonably attractive valuations.
The sectors that will lead the way in terms of relative performance once QE3 draws to a close remains to be seen. Of course, economic and market conditions have their own unique characteristics at any given point in time. But if history is any guide, a select group of sectors and industries have the ability to perform well even if the broader market falls into decline. And many of these same sectors may be setting up well to continue this outperformance trend and streak into 2015 once the market is left standing naked without the support of further stimulus from the Fed.
Disclosure: This article is for information purposes only. There are risks involved with investing including loss of principal. Gerring Capital Partners makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made. There is no guarantee that the goals of the strategies discussed by Gerring Capital Partners will be met. I am long XLU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I am long the stock market via the SPLV and selected individual stocks. I am also long the real estate industry via selected individual REITs. In addition, I hold a meaningful allocation to cash at the present time.