went on a roller coaster in the third quarter. Cyclical sectors,
those most tied to economic growth, outperformed, while defensive
sectors lagged most in the period.
Materials Select Sector SPDR (
) surged 3.9% in September and 9.5% in Q3, driven mainly by a
sudden turnaround in metals and mining stocks, which had lagged
most of the past year.
Materials companies' third-quarter earnings were flat compared
with the year-ago period after contracting 8% in the second
quarter, according to Thomson Reuters.
S&P Capital IQ analysts recommend that
underweight materials stocks relative to broad market indexes in
the fourth quarter because of volatile commodity prices, weak
earnings growth and high valuations. They're trading at 18 times
2013 earnings vs. 15.6 for the S&P 500.
"Subdued global macroeconomic outlook in the U.S., Europe,
Japan and many other developed economies, and slowing demand from
emerging markets for metals and mining products, is limiting
commodity price gains," Alec Young, global equity analyst at
S&P Capital IQ, wrote in a report Sept. 26.
Industrial Select Sector SPDR (
) added 5.3% in September and 8.8% in Q3. Industrials are
estimated to grow earnings 5.4% in Q3, just slightly better than
the S&P 500's 4.6% uptick.
S&P Capital IQ suggests weighting industrial stocks in
line with the broad market "due to expected sales benefits from
rising emerging and frontier market exposure, an improving
housing-led U.S. recovery, stabilization in Chinese growth in the
7% area, Europe's return to growth and easing U.S. fiscal drag,"
Young wrote. "In addition, operating leverage is rising with
revenues thanks to aggressive cost cutting and manufacturing
automation initiatives put in place by most companies during the
extreme business downturn of 2008 and 2009."
Defensive sectors lagged the most in the third
quarter.Consumer Staples Select Sector SPDR (
) andUtilities Select Sector SPDR (
) ended the three months nearly flat.
Consumer staples companies grew earnings nearly 5% in the
third quarter, an improvement from the 3.4% growth in second
quarter. Young rates staples market weight and utilities
In regards to staples, Young wrote: "Global sales volume gains
are expected to be driven largely by higher marketing
expenditures, and increased sales in developing markets. However,
with U.S. unemployment expected to stay relatively high in 2013,
we think less expensive private label goods will remain
attractive to many consumers, limiting the sales growth of
branded goods companies. In addition, while commodity price
inflation has eased, pricing power remains limited due to
relatively soft volume growth."
And as for utilities: "With only modest improvement expected
in the housing and power markets for 2013, the sector's EPS
outlook is below average. However, we still expect the sector's
high dividend yield (recently at 4.1%) to at least be maintained,
if not rise slightly, and think electric utility revenues and gas
utility gross margins will increase."
Utility company earnings were nearly flat year over year in
Q3, after declining nearly 4% in Q2.
Sector Bets For Fourth Quarter
Young recommends overweightingConsumer Discretionary (
),Financials (XLF) andHealth Care (XLV). These returned 7.5%,
6.2% and 2.4% in Q3, respectively.
Young reasons that consumer discretionary should benefit from
accelerating economic growth in 2014 as the housing market
continues to recover, companies expand foreign sales and tech
companies introduce new products. Financials' earnings prospects
will improve as long-term interest rates -- at which they lend --
rise and short-term interest rates -- at which they borrow -- are
kept near zero by the Federal Reserve.
"European sovereign stress is at manageable levels, helping
ease fears of global credit market disruption and boosting
investor sentiment towards the sector," Young wrote.
Health care is a cheap, defensive play that should reap
profits from new drugs, emerging markets and merger and
acquisitions. In addition, drug companies are paying dividends
and are more efficient in their research and development.
Discretionary stocks boosted earnings 8% in Q3 year over year
and health care 4%. The financial sector, up 10%, increased
earnings the most in Q3.
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