Investment Research Update:
Third Quarter 2023

Cyclical Sectors May Outperform

Fidelity's director of quantitative market research Denise Chisholm offers data-driven views of the markets, equity sectors, and other investment building blocks, such as factors and thematic strategies.

Key takeaways

  • Investors weighed a shifting outlook during the second quarter, as inflation fell but stayed high, the U.S. Federal Reserve raised interest rates more slowly, and a bank crisis unfolded.
  • The information technology, communication services, and consumer discretionary sectors led the stock market during the quarter as investors turned their focus to cyclical stocks.
  • Utilities, energy, and consumer staples were the bottom performers for the quarter.

Several Cyclical Sectors Looked More Attractive

Within the S&P 500® index, the information technology, communication services, and consumer discretionary sectors led during the second quarter, as investors turned their focus to cyclical stocks. Fundamental, valuation, and relative strength signals appeared mixed overall at the end of June. That said, there may be a higher margin of safety in several cyclically oriented sectors, including consumer discretionary, mainly due to relative valuations.

Technology Stocks May Offer a Bullish Sign

U.S. technology stocks (within a Fidelity list of the top 3,000 stocks by market capitalization) gained 13% in April, easily reaching the top decile of one-month tech sector returns since 1962. Over this historical span, top-decile monthly tech sector returns have tended to coincide with strong forward 12-month returns for the overall market. Also in this time frame, cyclicals were more likely than defensive sectors to outperform the top 3,000 stocks.

High Valuations Spreads Have Signaled Strong Returns

At the end of May, valuation spreads—the gap in valuation between the cheapest and most expensive groups of stocks in the Russell 3000 Index based on quartiles of book yield—were in the top 5% of the market's historical range going back to late 1990. Stocks in this broad-based index historically posted strong average gains after valuation spreads reached this extreme.

Industrials Appeared Cheap

Industrials with the Fidelity list of the top 3,000 stocks by market capitalization looked inexpensive as of May, with valuations falling to their bottom historical quartile going back to early 1962, based on price-to-book ratio relative to the market. Historically, when the sector reached bottom-quartile relative price-to-book, it outperformed the market 71% of the time over the next 12 months.

EXHIBIT 1: Information technology led the market in Q2, while utilities lagged.

Performance as of 6/30/23SectorLatestQuarter1-Year3-YearAnnualizedDividendYieldWeight inS&P 500®S&P 500®Communication ServicesConsumer DiscretionaryConsumer StaplesEnergyFinancialsHealth CareIndustrialsInformation TechnologyMaterialsReal EstateUtilities13.1%14.6%0.5%-0.9%5.3%3.0%6.5%17.2%3.3%1.4%-2.5%8.7%17.3%24.7%6.6%18.8%9.5%5.4%25.2%40.3%15.1%-4.4%-3.7%19.6%7.3%9.0%11.9%35.4%15.6%11.7%18.0%20.0%16.0%6.1%8.4%14.6%0.8%0.9%2.5%3.8%1.8%1.6%1.6%0.8%2.0%3.4%3.2%1.5%8.4%10.7%6.7%4.1%12.4%13.4%8.5%28.3%2.5%2.5%2.6%

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