Now that the S&P 500 has remained in positive territory YTD for a few days, it’s time to consider what sectors are outperforming and why. The easiest way to do this is to track the performance of the various sector SPDR ETFs, which will give you a general sense of which sectors are doing the best:
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It’s pretty easy to spot the winner: healthcare. Last year, the winner wasn’t so clearly ahead—and it wasn’t healthcare:
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Near the end of the first quarter of 2013, energy was inching ahead of healthcare, which was still holding its own. But it was a much tighter race. But in 2014, healthcare is winning by a large margin.
If we look at this sector more closely, we see that healthcare is beaten by the biotechnology sector, as represented by the NASDAQ Biotech index ETF (IBB):
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IBB did well for the same period in 2013, when it was up about 10%, but this year it is the clear winner in a market that, while still bullish, is by no means on the same aggressive run that we saw in 2013.
The growing divergence between the various sector SPDR funds is a good thing for money managers and bad for passive investors, which suggests that the recent vogue in index investing will substantially cool by the end of the year. The correlation between a stock’s performance and the performance of the market in general is growing less acute for all stocks, which means that it is becoming more and more important to pick winners.
This is true both at the sector level and at the individual stock level. We see that Gilead (GILD) is up 7.5% for the year, but if we compare that to Mylan (MYL), we can easily get depressed if we held GILD: MYL is up 25% YTD. And that is a laggard compared to many small cap biotech stocks, many of which are up 50% or even over 100% for 2014 alone.
The skills involved in picking biotech stocks are much different from stock picking for the rest of the market. It involves a deep fundamental knowledge of chemistry, biology, FDA regulations, and much more. Many hedge funds leverage biomedical scientists and PhDs in experimental medical fields to do these kinds of analyses for them. The risk in this sector is substantial, and it is difficult to enter as a layperson investor.
This has always been true of biotech stocks, but it is much more important in a market that is more horizontal than vertical, In 2013, investors could get high double digit returns while avoiding the difficult biotech stocks. This year, that will be harder to do.
As it goes with biotech, though, it is likely to go with other industries. A deep knowledge of the fundamental potential of companies in finance, media, technology, retail, and others is becoming much more important than it was in 2013. Again, this is great news for money managers—their ability to pick stocks is going to become much more valuable to investors looking for expertise. But it also means analysts will need to spend more time studying and understanding the fundamental business model of the companies they invest in.