I have reported the wide dispersion of performance across different asset classes so far this year in previous blog posts. There are clear winners and losers so far this year and nothing is more telling than the wide dispersion of returns amongst the S&P asset class sectors. Perhaps unsurprisingly, this wide dispersion has been a major detriment to income strategies this year.
The S&P 500 index is classified into 11 broad industry categories including information technology, health care, financial, consumer discretionary, consumer staples, communication services, industrials, energy, utilities, materials and real estate. Each of the sectors includes companies that have business characteristics unique to that sector. In the current COVID-19 environment, the sector performance has diverged in a meaningful way.
As seen from the chart below, the information technology sector (the bright pink line at the top) has led the performance of all other sectors and the S&P 500 (the bold black line) by a wide margin. Huge laggards include energy (the purple line at the bottom), financials (light blue line), industrials, and utilities. The consequences of this are significant and have an impact on targeted strategic approaches, especially strategies targeting income.
Strategies targeting income usually look for investments that have a few common characteristics including consistency of payments, lower price volatility, and higher portion of return coming from income versus price appreciation. These traits all tend to cluster in stocks in the four S&P sectors that have generated the weakest YTD performance being energy, financials, industrials and utilities. For example, the iShares Select Dividend ETF (DVY), a popular $12 billion high dividend-paying ETF, has its largest sector allocations totaling 56.8% in financials, utilities, and energy causing its staggering 2020 YTD return of -25.01% compared to the S&P 500 that is down only -1.4%.
So, unlike the tremendous recovery we have seen in other sectors from the lows in mid-March, these weak sectors have not shown a similar bounce-back. It appears that the market is assessing a prolonged period of weakened earnings and ability to pay dividends from these sectors.
The question, of course, is how long this situation will persist. No one knows the answer to that, but this is certainly not a situation like the Dot-Com Bubble in 2000 where many of the companies were wiped out and went out of business. Like always, patience is needed during times like this. A long term investor will be rewarded by holding a diversified portfolio of quality investments.