Four Key Drivers of Equity Sector Performance

Higher oil prices are obviously a good thing for energy companies.  Generally speaking, oil producing and oil services firms benefit from higher prices and, in turn, are hurt by lower prices.  As such, it comes as no surprise that energy stocks tend to outperform the S&P 500® when crude oil prices are rising and underperform when prices are falling (Figures 3 and 4).  Higher energy prices have also correlated with the outperformance of materials stocks and to a lesser extent with financial stocks.  The latter isn’t too surprising given that many financial firms have lent a great deal of money to the energy sector.  Most other sectors have a negative sensitivity with respect to oil: they tend to underperform the S&P 500® index when oil is rising and outperform when it’s falling. 

Consumer and health stocks appear to be especially penalized by higher energy prices.  When consumers have to pay more for energy, they have less money for everything else, including consumer staples and health care.  

In fact, consumer staples and health care stocks are even more negatively sensitive to oil price changes than are consumer discretionary stocks.  This may be because lower-income consumers spend a greater portion of their budget on energy, consumer staples, and health care than higher-income consumers.  Thus, lower-income consumers have to make painful choices when oil prices rise and may have to sacrifice essentials.  Higher income consumers are less impacted by oil prices as energy represents a smaller share of their budget.  At the same time, higher earners are more prone to buy discretionary goods, which have shown less sensitivity to changes in energy prices than the consumer staples or health care sectors. 

Expectations regarding changes in the U.S. Federal Reserve’s (Fed) monetary policy have also been a major factor driving the relative performance of different sectors versus the S&P 500® as a whole.  Fed Funds Futures explicitly measure the expected change in the Fed’s target rate.  Financial stocks tend to benefit from the possibility of higher Fed rates whereas most other sectors, notably utilities, energy and consumer staples stocks, tend to underperform (Figure 5).  Investors in bank stocks appear to very eager to see the Fed move rates higher, which should help banks and asset managers become more profitable.  Utility stocks, which tend to pay high dividends and compete with fixed income for investors, are the most affected.  Energy stocks have also reacted negatively to the possibility of higher interest rates, in part, because many of them enjoyed cheap financing and geared up significantly during the oil boom.

What is less intuitive is the negative reaction of utilities and consumer goods to increases in copper prices.  Rising copper prices might indicate a global economic recovery, which could encourage the Fed to raise rates to the detriment of utility and consumer staples stocks.  

The Bloomberg Dollar Spot Index tracks 10 currencies, namely, the Euro (31.75% weight), Japanese yen (18.45%), Canadian dollar (11.48%), Mexican peso (9.87%), British pound (9.46%), Australian dollar (6.1%), Swiss franc (4.37%), Korean won (3.43%), Chinese renminbi (3.00%) and Brazilian real (2.08%).  Movements in the U.S. dollar versus this basket of currencies are a major influence on the relative performance of the various equity sectors.

In general, and given the other factors, stocks respond negatively to a stronger currency as it tends to put downward pressure on earnings accrued abroad, and exposes domestic producers to stronger international competition.

Bottom Line:

• During the past year, more than half of the relative performance of E-mini Energy Select Sector Future versus the S&P 500® Future can be explained by four factors: daily changes in the price of crude oil, short term U.S. interest rates, copper and the U.S. dollar.
• More than one fifth of the relative performance versus the S&P 500®of the E-mini Financial, Consumer Staples, Materials, and Utilities Select Sector Futures can be explained using these same four factors.
• Rising oil prices tend to benefit energy and materials stocks and hurt most other sectors, notably consumer goods and health care.
• Increased expectations of interest rate increases tend to benefit financial stocks but are detrimental to utility, energy and consumer staples shares.
• Financial stocks tend to benefit relative to the S&P 500® from a stronger dollar but a stronger U.S. currency is detrimental to most other sectors outside of health care and technology.
• Higher copper prices are likely to benefit materials stocks on a relative basis but have modest effects elsewhere.

All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only.  The views in this report reflect solely those of the authors and not necessarily those of CME Group or its affiliated institutions.  This report and the information herein should not be considered investment advice or the results of actual market experience.