Market Strategy: Sector vs. Style

By Matthew Hougan

Jim Wiandt and I have been engaged in a debate over which matters more: style or sector.

Actually, it's not much of a debate. Right now, I think it's fair to say we both agree that sectors are driving market performance much more than style. One need look no further than Financials for proof of that.

With that in mind, I thought it would be interesting to look at the way sector and style interact, with a simple look at the sector breakdown in each of the nine sector style boxes.

To make my analysis easier, I'm using exchange-traded funds as proxies for the different style boxes. One of the great things about ETFs is that providers have invested huge amounts of money into their Web sites, and they make loads of data available for free to investors.

I'm using the S&P-based style box ETFs from iShares for my analysis, although any index and ETF family would do.

Total Market

First, to set the stage, let's look at the breakdown in the total U.S. market. The index for that is the S&P 1500, represented by the iShares S&P 1500 Index Fund (NYSEArca: ISI).

Despite the pullback in Financials this year, as of October 2, 2008, they were still the single largest sector of the market, at 16.59% of the index. After that, you have Information Technology (15.41%), Health Care (13.39%) and Energy (12.15%).

Here's the complete table. 

S&P 1500
Financials	16.59%
Information Technology	15.41%
Health Care	13.39%
Energy	12.15%
Consumer Staples	11.75%
Industrials	11.13%
Consumer Discretionary	9.07%
Utilities	4.04%
Materials	3.44%
Telecommunication Services	2.83%

Large-Caps

Next up was large-caps. The funds here are the iShares S&P 500 Index Fund (NYSEArca: IVV), iShares S&P 500 Growth Index Fund (NYSEArca: IVW) and iShares S&P 500 Value Index Fund (NYSEArca: IVE).

Not surprisingly, the sector breakdown for the broad S&P 500 looks a lot like the S&P 1500; after all, the S&P 500 makes up the majority of the market capitalization in the S&P 1500.

But when you get to the Value and Growth indexes, things get very interesting. These two indexes don't just tweak their exposure to the various sectors; they change it radically.  The S&P 500 Value ETF has a 28.37% weight in Financials, nearly 75% greater than the S&P 500 itself.  Meanwhile, Financials make up just 5.11% of the S&P 500 Growth ETF.

Conversely, Information Technology and Energy make up 44.75% of the S&P 500 Growth ETF, and just 10.67% of the S&P Value ETF.

If you want to know what's driving the performance of these Growth and Value subsets, that's it.

click to enlarge

Mid-Caps

The differences are even more pronounced in the mid-cap sector. For starters, the iShares S&P MidCap 400 Index Fund (NYSEArca: IJH) has much higher allocations to Financials (19.55% vs. 16.59%), Industrials (14.62% vs. 11.13%) and Consumer Discretionary (13.81% vs. 9.07%) than the broad S&P 1500.

But the differences are again severely exaggerated when you move into Growth and Value. The iShares S&P MidCap 400 Growth Index Fund (NYSEArca: IJK) is strongly overweight Health Care (20.30% vs. 12.48%) and Consumer Discretionary (20.06% vs. 13.81%) vs. the S&P 400, and strongly underweight Financials (7.73% vs. 19.55%).

By contrast, the iShares S&P MidCap 400 Value Index Fund (NYSEArca: IJJ) is hugely overweight Financials and Utilities. Fully 30.06% of the fund is allocated to Financials, and 14.26% to Utilities. If you want to know how mid-cap value will perform, there's your clue.

Small-Caps

The story is similar in small-caps. Compared with the broader market, the iShares S&P SmallCap 600 Index Fund (NYSEArca: IJR) is overweight Financials (19.82% vs. 16.59%), Industrials (17.39% vs. 11.13%) and Consumer Discretionary (14.29% vs. 9.07%), and underweight Energy (5.98% vs. 12.15%) and Consumer Staples (4.29% vs. 9.07%).

On the growth and value segments, the story is familiar. The iShares S&P SmallCap Growth 600 Index Fund (NYSEArca: IJT) is overweight Health Care and Consumer Discretionary, and underweight Financials. The iShares S&P SmallCap Value 600 Index Fund (NYSEArca: IJS) is overweight Financials (27.07% of the fund) and Utilities, and underweight Health Care and Energy.

Financials

Given how starkly important Financials are at the moment, and how widely exposure varies in the indexes, I thought it'd pay to look at all nine style box exposures to Financials side by side.

From 5.11% to 30.06% ... Gee, do you think that sector exposure might have something to do with returns? 

Index	Financials
S&P 500	16.21%
S&P 500 Growth	5.11%
S&P 500 Value	28.37%
S&P MidCap 400	19.55%
S&P MidCap 400 Growth	7.73%
S&P MidCap 400 Value	30.06%
S&P SmallCap 600	19.82%
S&P SmallCap Growth 600	10.97%
S&P SmallCap Value 600	27.07%

Comments

[granger:]

One of the best article I have read. Great info, very insighful tool for understanding price performance. Thank you.

2008 Oct 11 02:41 AM

[DonaldRay:]

Very helpful information.

Jan 01 11:47 AM