The Best And Worst Sectors For 2018

At the end of 2017, I wrote this piece that looked at what we can expect from the market in 2018, and concluded that we can expect another good year for stocks. That view is based on the simple fact that economic fundamentals, both here in the U.S. and globally, are strong.

The recovery from the recession has been slower than most would like, but with governments now moving towards more expansionist, growth oriented policies and consumer confidence recovering, an acceleration of growth is definitely on the cards. Obviously, having a base case off which to make decisions is important for traders and investors, but the question most are asking is how best to play the expected strength.

There are two ways to look at that. Will we see more of the same, or will we see a rotation that makes last year’s laggards this year’s stars? History suggests that the old investing cliché that everything reverts to the mean will apply, and that the worst performing sectors of 2017 will be the place to be.

The current reality, however, suggests otherwise.

As you can see from the below table from Fidelity, the two worst performing sectors over the last year have been Energy and Telecoms, but both have lagged for good reason.

Energy companies are still suffering from the big drop in oil prices that came a few years ago, and depressed natural gas prices. The fact that oil has opened this year around $60 and that the current White House views the industry favorably may make you think that a dramatic recovery is coming, but that would be a mistake.

The opening up of previously restricted areas for drilling is good for the industry in the long term, but given that oversupply is what has kept prices down it does not bode well for prices this year. Add in the rapid developments in electric vehicles that threaten oil demand and a strong recovery in energy stocks looks extremely unlikely.

The other factor that will continue to weigh on energy is also the reason that Telecoms will probably underperform once again: a rising interest rate environment. Both industries have traditionally derived much of their value from offering high dividends, but assuming the Fed continues to gradually raise interest rates, those dividends have a relatively lower value.

That will hit Telecoms, but, as with energy, there are also other factors that will hurt. Companies in the sector tend to have heavy debt loads that will become even heavier as rates rise, and there is no reason that the intense pricing competition in the industry will end any time soon.

If anything, Telecom looks to be in a worse place than even energy this year.

So, if last year's underperformers aren’t the places to be, what are? Referring again to the table above, the top two sectors in 2017 were Information Technology and Materials. It is tempting to look at them and think “What goes up must come down”, but the factors that have driven both sectors for the last year are set to continue, or even gain pace.

The tax bill that was passed at the end of the year will, I’m sure, lead to investment by corporations in 2018, but if you think that means that there will be massive investment in traditional production facilities that provide jobs you haven’t been paying attention.

It is far more likely that most will target their investment towards increasing efficiency, even as they expand production, and that means investing in tech above all else.

The outlook for materials is therefore less about domestic investment than it is about global growth, except for one thing. President Trump and other Republican leaders, fresh off showing us that they can get legislation passed and that deficits no longer matter, are reportedly now looking at a big infrastructure spend this year. That will lead to increased demand for materials, or at least the expectation of increases, and that, combined with the global growth environment, will result in another banner year for materials.

Apart from last year’s laggards and leaders there are a few other sector strategies that should be adopted for 2018. The improvement in consumer confidence and spending will benefit Consumer Discretionary and Real Estate stock this year, although the rising rates do represent a bit of a threat to real estate. That is also the reason why Utilities will continue to struggle relative to the broader market.

Another area to avoid this year is Healthcare. The repeal of just the individual mandate from Obamacare is about the worst possible scenario for the sector, as it will lead to a larger pool of uninsured and underinsured while still leaving coverage requirements and other expenses for insurers and providers in place.

The overall conclusion then is that we are in for more of the same. Last year’s patterns will be repeated. Tech and Materials continuing to do well along with Consumer Discretionary and Real Estate stocks, while Energy, Telecoms and Healthcare are best avoided.

Starting the year with that bias and staying alert for the kind of “black swan” events that can turn things on a dime should make for a happy and prosperous 2018.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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