The inevitable rise and fall of market sectors

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What goes up, must come down. The dynamics of this principle of physics, elucidated by Sir Isaac Newton in the 17th century, can be applied to the performance fluctuations of stock market sectors.

Consistent with Newton’s universal law of gravitation, elevated stock sectors will eventually fall and depressed ones will rise as investment flows from the played to the promising.

Today, physicists put Newton in the same league as Einstein for discovering the pattern of planets’ revolution around the sun, using nothing more than a small telescope. He determined the planets’ relative positions throughout their elliptical solar orbits, and showed all this with astonishingly accurate math.

Not Science

These orbits never change (at least not since the advent of humankind). By contrast, the order of stock sectors, in terms of performance, definitely does. Precisely when this order will change can’t be accurately predicted because the market isn’t science. But it does have a well-documented history. And though history doesn’t reliably repeat, it often rhymes, and can be used as a guide to what’s likely to happen.

Realignments of sector performance—rotations in their rankings—have historically occurred generally about every one to three years according to Omar Aguilar at Schwab Asset Management. Any chance of a sector rotation in 2022 was rendered moot by the bear market, in which pretty much everything fell. So the odds of a sector rotation in 2024 are pretty good.

Sector rotation will mean the broadening of performance — sectors in the S&P 500 index of large-company stocks doing better. That index was up over 20% year to date as of early December, after one of the market’s best months in decades.

The performance of the S&P 500 has been driven by the same huge tech companies propelling the tech-heavy Nasdaq 100 index, up over 45% year to date as of early December.

These tech behemoths are known as the Magnificent Seven, after the 1960 Western. They are: Meta (formerly known as Facebook), Alphabet (formerly Google), red-hot semiconductor company Nvidia, Tesla, Microsoft, Amazon and Apple. (The group’s moniker may be a bit vainglorious, as if Elon Musk of Tesla or his rival for nerdy machismo, Mark Zuckerberg of Meta, had the charisma of Steve McQueen or Yul Brynner.)

Broadening Magnificence

While most of these stocks may post good gains in 2024, some smaller but still large tech companies may hold more potential for growth. These include Qualcomm (QCOM), Motorola Solutions (MSI) and Accenture (CAN).

However, the artificial intelligence capabilities being developed at some of the Seven (including Microsoft and Amazon) could be a real turbocharger over the next few years. And like the introduction of personal computers and cell phones late in the last century, AI could have a big impact on business productivity growth, benefiting the overall market.

AI is the latest new thing in the digital revolution, which has led the stock market for decades and likely will for decades to come. Though sectors will probably rotate in 2024, tech may very well continue to lead, and the Magnificent Seven will likely continue to thrive.

Regardless, there will probably be rotation in performance rankings, at least in the other 10 sectors. Sectors likely to improve in 2024 and move into higher positions in the performance pecking order include:

Industrials. These are companies that make stuff. Names with potential for pop include Snap-on (SNA), Insperity (NSP) and Trane (TT).

Consumer discretionary. These companies, which provide nonessential yet desirable goods and services, should do better than those in the other consumer category, staples— essentially, necessities. Staples are plagued by elevated input costs from inflation, depressing profit margins. Discretionary names with good potential in the coming months include Dick’s Sporting Goods (DKS), Home Depot (HD), Academy Sports (ASO) and Ethan Allen (ETD), a small-cap name.

Financials. This sector had some rough sledding in 2023 from disaffected investor sentiment stemming in part from fears that the problems at a few regional banks would somehow go viral through the broader industry. That didn’t happen. And now, the chart of SPDR S&P Regional Banking ETF (KRE) looks as if the fund has technically broken a long-term downtrend. Fears linger nonetheless. Banks are demonstrating more energy now, boding well for 2024. Picks include: First Bancorp (FBP) and OFG Bancorp (OFG) — both beaten-up regional bank stocks that show promise for a continued rebound— and JPMorgan (JPM). Non-bank financials are currently quite strong and should stay that way: Hartford (HIG), Fiserve (FI) and CME Group (CME).

Real estate. This sector is easily accessed through real estate investment trusts (REITs), landlord companies that own and lease out all kinds of property. Up about 12% in November, REITs were one of the three best performers that month, along with financials and tech. The current pause in, and likely end of, interest rate increases by the Federal Reserve board has done wonders recently for REIT performance, which analysts have summarily punished during rate-hiking cycles because they depend on loans to buy and refurbish rental property. Yet, sustained elevation of rates, without further hikes, isn’t really a downside for these landlord companies, particularly those with short lease terms.

Suppressing Prices

Giving 2023’s laggards even more potential for growth, by suppressing investment and pushing down their prices, is the stalwart cynicism that many investors of all stripes have about the market and the economy. Though many large investment houses have brightened equities outlook for 2024 and economists have reduced their estimates of the likelihood of recession, these people can’t manage to get earlier, now-dated negative views out of heads.

By clinging to this view, many investors may miss out on what’s shaping up to be pretty good overall performance in 2024.

They remain stuck in now-dated negative mire—despite the stock market’s growth in 2023, its recent spurt and a brightening of earlier economic and market forecasts.

These people have bought into the rigid idea that bringing down inflation through interest rate increases necessarily results in recession. Yet this orthodoxy developed from the results of decades of monetary policy changes by the Fed in normal economies and normal markets. And the post-pandemic economy/market has been anything but normal.

Some investors are finally realizing that bringing inflation down doesn’t always mean a recession. Many other investors have caught on. Says renowned market economist Ed Yardeni: “The market is rejoicing with this realization.”

Sure, challenges lie ahead, but 2024 currently looks pretty good, especially considering where we’ve been. Yardeni sees the likely course of decade as similar to the 1920s—starting out with post-pandemic problems (then, Spanish flu) but finishing strong after years of strong market performance.

They Will Spend

A widespread fear among stubbornly negative voices is the recessionary vision of the future they cling to will result in lower spending by consumers, the dominant force driving the U.S. economy. They overlook the statistical reality that spending is actually a value of American culture, as Yardeni succinctly points out: “Americans spend money when happy, and when they’re depressed, they spend more.” And spending was brisk on Black Friday.

Pessimists harp on the less-than-confident views expressed recently by respondents in consumer sentiment surveys. Yet there’s historically been a disconnection between such survey results and how much people actually spend. Watch what they do, not what they say.

The pessimists counter that credit card balances are way up but they ignore the reality that this comes amid higher wages and full employment. Consumer are going into more debt at a time when they’re earning higher wages and more people are employed.

Unlike the planets in Sir Issac’s constant solar system, the performance of different stock sectors will inevitably shift in order. This is almost as certain as the eventuality that planets will follow the same solar orbits today as they did in the 17th century.

Anticipating likely performance shifts and buying shares of worthy stocks in those sectors early on, perhaps soon after they start to rise, may not get you knighted. But it will probably increase your equity portfolio returns.

Dave S. Gilreath, CFP, is a founding principal and CIO of Sheaff Brock Investment Advisors, an investment firm for individual investors, and Innovative Portfolios®, an institutional money management firm. Based in Indianapolis, the firms manage assets of about $1.3 billion. The investments mentioned in this article may be held by those firms, Innovative Portfolios’ ETFs, affiliates or related persons. There may be a conflict of interest in that the parties may have a vested interest in these investments and the statements made about them.