Top Performing Sector ETFs: 1Q 2018

2018 is seeing a wide variation in sector performance, creating pitfalls and opportunities for active investors.

Despite this year’s breathtaking moves in the stock market, the major stock index averages are doing pretty well.

After plunging nearly 12% from its highs in February, the S&P 500 clawed back to last trade with a 4.1% gain for the year. Not many investors are going to be complaining about that type of return in a little over two months.

At least so far, concerns about rising interest rates, faster inflation, and more recently—trade wars—have all been successfully absorbed by the market. But those market worries haven’t affected each sector within the market the same way.

A look under the hood reveals a wide divergence in the performance between the 11 stock market sectors. In fact, about half of them—five of 11 sectors—are down for the year. The worst of the bunch is down by 8.9% so far in 2018, while the best is up 11.9%. 

Note: Data measures the year-to-date return through March 9.

Tech A Powerhouse

This year’s sector powerhouse is the same one as last year: technology. After climbing more than 37% in 2017, the Vanguard Information Technology ETF (VGT) is already up 11.9% in 2018, and trading at an all-time high.

It’s not hard to understand why investors remain so enthusiastic about tech. The sector is filled with cash-rich, high-growth companies, including Google, Facebook and bitcoin-mining chipmaker Nvidia, to name a few. Tech revenues are estimated to grow by 11% this year, the second-highest growth rate among all sectors, according to FactSet.

“You look at tech and think, ‘What’s the catalyst that’s going to bring it down?’ I don’t see one in the short term, and that makes me confident as a trader to go into those stocks that have been the leaders,” said Dennis Dick, a proprietary trader at Bright Trading.

Other Side Of The Coin

Of course, there are two sides to every story. Tech has outperformed the rest of the market to such an extent that some analysts are warning it may be getting risky. The tech sector now represents a whopping 25% of the S&P 500—which helps explain why the broad index has posted a solid return this year despite declines in other sectors.

Tech’s weighting is not quite as high as it was during the dot-com bubble, when it grew to as large as a third of the S&P 500, but it’s gotten to the point where people are taking notice.

"It bears watching for sure," said analysts at Bespoke Investment Group. "A weighting of 25%+ is ... nothing to sneeze at.”

That said, tech’s weighting in the broader market could drop later this year regardless of what happens with share prices. In September, S&P Dow Jones Indices and MSCI will move current tech giants like Alphabet (parent company of Google), Facebook and others into the new communication services sector under the Global Industry Classification Standard.

Those two companies alone have a combined market capitalization of $1.3 trillion. Reclassifying them from tech to communications will surely put downward pressure on tech’s weighting in the broader stock market.

High-Yielding Sectors Lag

Sharply contrasting with tech’s dominant performance are five others sectors that are in the red for 2018, falling far behind the broader market this year.

The Vanguard Telecommunication Services ETF (VOX) is down 1.7%; the Vanguard Consumer Staples ETF (VDC) is down 3.7%; the Vanguard Energy ETF (VDE) is down 5.4%; the Vanguard Utilities ETF (VPU) is down 6.4%; and the Vanguard Real Estate ETF (VNQ) is down 8.9%.

While clearly a disparate group, all of these sectors share one important commonality: They yield much more than the overall stock market. The S&P 500 currently yields about 1.87%, while the five aforementioned sector ETFs have yields between 2.6% and 3.8%.

With rising interest rate and inflation worries front and center for investors, it’s not surprising these high-yielding sectors have fallen out of favor. The U.S. 10-year Treasury yield briefly hit 2.95% last month, the steepest level in four years.

With Treasury yields climbing, there’s been less incentive for income investors to reach for yield in sectors like utilities and real estate.

“The utility market has been very much moving in lockstep with the 10-year Treasury,” said John Bartlett, portfolio manager and utility analyst for Reaves Asset Management.

At the same time, Matt Kopsky, REIT analyst at Edward Jones, said that, in the near term, “it’s all about interest rates” when it comes to real estate stocks, while adding they will “likely underperform if the 10-year yield continues moving higher to 3%-plus.”

Trade Worries

Interest rates haven’t been the only thing causing investors to be jittery recently. All the talk of about trade wars has weighed on industrials and materials stocks.

The Vanguard Industrials ETF (VIS) and the Vanguard Materials ETF (VAW) are up both up year-to-date—by 2.8% and 1.3%, respectively—but that’s less than the market return.

Some investors fear that the steel and aluminum tariffs enacted by the U.S. last week could hurt companies in these sectors, which are big exporters and consumers of raw materials.

On the other hand, sectors like consumer discretionary, financials and health care have largely been insulated from investors’ trepidation about trade. These sectors, which have a greater focus on the domestic economy, are all up more than the overall stock market.

The Vanguard Consumer Discretionary ETF (VCR) is up 6.7%; the Vanguard Financials ETF (VFH) is up 6.3%; and the Vanguard Health Care ETF (VHT) is up 5.8%.

Rising interest rates also haven’t been much of a worry for these sectors, which all yield less than the S&P 500. Indeed, higher rates can actually be a benefit for the financial companies like banks, which can charge more for the loans they make.

Follow Sumit Roy on Twitter @sumitroy2