Sector Views: Monthly Stock Sector Outlook

Schwab Sector Views is our six- to 12-month outlook for stock sectors, which represent broad sectors of the economy. The Schwab Center for Financial Research (SCFR) combines a factor-based approach with a market and economic assessment to determine the ratings. For the basics on sectors, please see Stock Sectors: What Are They? How Are They Used?

Sector views

Financials, Energy and Materials remain Outperform, while Real Estate and Consumer Discretionary remain Underperform. Three sector ratings are the result of factor model overrides: Real Estate's Underperform rating is based on weak fundamentals, including high interest rates and building vacancies; Communication Services' factor rankings are likely skewed by the dominance of a few large stocks in the sector; and Information Technology has good growth prospects, in our view, and again its factor ranking is skewed by the dominance of a few mega-cap stocks.

Sector ratings

Source: Schwab Center for Financial Research, as of 5/27/2024.

The ratings Outperform, Marketperform, and Underperform reflect SCFR's opinions about the likelihood that the sector will perform better (outperform), about the same (marketperform), or worse (underperform) than the broader S&P 500^®index during the next six to 12 months. Asterisks (*) mean that SCFR overrode the factor model in determining the rating. Sectors are based on the Global Industry Classification Standard (GICS®), an industry analysis framework developed by MSCI and S&P Dow Jones Indices to provide investors with consistent industry definitions. Sectors are listed in the above chart in order of their performance in five factors that are shown in the chart below. The information here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. Investing involves risk, including loss of principal.

Factors behind the stock sector ratings

Source: Schwab Center for Financial Research, S&P Dow Jones Indices, as of 05/27/2024.24.

Sectors are ranked as positive (+), neutral (N) or negative (—) for each of the five factors based on the sector's relative ranking (from 1-11) in each factor: 1-3 is positive, 4-8 is neutral, and 9-11 is negative. See Important Disclosures for an explanation of the Value, Growth, Quality, Sentiment and Stability factors and their inputs. The Schwab Center for Financial Research reserves the right to override the Schwab Sector Views Model; see "Sector Views Process" below for an explanation of how SCFR determines its ratings.

Stock sector commentary

(Sectors are listed in alphabetical order)

Communication Services sector (rating: Marketperform)

Positives: Communication Services relies heavily on advertising and subscription-type revenue, which tends to rise when the economy is expanding.

Risks: The sector may underperform if economic growth slows. A persistent risk is the dominance of bigger members, which command a large share of the sector's market cap and thus determine much of its performance.

Consumer Discretionary sector (rating: Underperform)

Positives: Companies tend to be sensitive to economic activity, as consumers buy discretionary items more readily when job growth is strong and interest rates are low.

Risks: Concentration risk is high for the sector, with the two largest members accounting for nearly half of the total market cap The other half of the sector is also at risk of any further softening in consumer spending and/or income growth.

Consumer Staples sector (rating: Marketperform)

Positives: Consumer Staples companies tend to be relatively insensitive to economic activity, as consumers buy staples regardless of economic conditions.

Risks: Companies can face shrinking profit margins in an inflationary environment without the pricing power to offset higher costs. Weaker earnings growth has made these stocks look expensive relative to the broader market.

Energy sector (rating: Outperform)

Positives: Energy stocks are generally supported by relatively high oil prices. The sector has exhibited high-quality aspects given a relatively high interest coverage ratio—that is, companies are relatively well-positioned to pay interest due on outstanding debt—and a still-strong level of earnings.

Risks: Earnings growth might struggle if oil prices continue to fall on the heels of both relatively weak demand and a continued recovery in supply.

Financials sector (rating: Outperform)

Positives: Some segments benefited from rising interest rates, which allow banks to lend at higher rates and insurance companies to increase returns on collected policyholder premiums. The economy has proven to be relatively resilient in the face of one of the most aggressive tightening cycles in history.

Risks: It is still too soon to tell whether long and variable lags associated with monetary policy should be ignored, which means the economy is not yet out of the woods. With significant tightening in the pipeline amid the fallout from last year's banking issues, Financials' profits trajectory might struggle relative to the broader market, which can weaken the earnings profile of the sector.

Health Care sector (rating: Marketperform)

Positives: Health Care tends to do well even when economic growth slows, as most people will find a way to pay for necessary health care treatment even during tough economic times (although elective procedures often decline). It also can get a boost when heightened market volatility drives investors toward stabler choices.

Risks: Several companies in the sector (particularly in the biotechnology industry) have weak fundamentals. Downward pressure on earnings estimates is helping lift multiples—that is, stock price relative to earnings—especially for risky industries like biotechnology, which is a risk as interest rates stay elevated.

Industrials sector (rating: Marketperform)

Positives: Industrials often benefit when economic growth raises business confidence, resulting in new building projects, machinery purchases, increased airline travel and shipments.

Risks: Industrials may underperform in the aftermath of rate-hike cycles as investors anticipate that higher inflation and borrowing costs can begin to undercut business and consumer spending.

Information Technology sector (rating: Marketperform)

Positives: Information Technology tends to do well when strong economic growth encourages companies to invest in technology upgrades and consumers to buy new devices. Some of the larger members are not in the "long-duration" camp—companies expected to produce their highest cash flows in the future—given they have current earnings growth and strong cash positions.

Risks: Many companies in the sector trade at higher multiples (price relative to earnings), and a rising-interest-rate environment puts downward pressure on valuations. Heavyweights in the sector are associated with the "stay-at-home" group that did well during the pandemic shutdown, but may face pressure as investors broaden their focus toward other stocks.

Materials sector (rating: Outperform)

Positives: The Materials sector historically is sensitive to fluctuations in the global economy, the U.S. dollar, and inflationary pressures. In a less-severe recession, the sector's profitability might not take as large of a hit.

Risks: Stocks tend to underperform during rate-hike cycles as investors anticipate that higher inflation and borrowing costs will undercut business spending. Materials relies heavily on foreign demand, and a stronger U.S. dollar tends to weaken sales abroad.

Real Estate sector (rating: Underperform)

Positives: Real Estate, which consists primarily of commercial real estate investment trusts (REITs), tends to benefit from economic growth, which supports rent collections and property prices.

Risks: Most REITs borrow heavily, making them vulnerable to high interest rates. The longer-term outlook for real estate is in question given uncertainty about a full post-COVID return to offices and major metro areas.

Utilities sector (rating: Marketperform)

Positives: The Utilities sector has tended to perform relatively better when economic growth slows, as consumers usually cut spending on other items before they stop paying utility bills.

Risks: The sector is heavily indebted, especially relative to cash flow. Economic data have come in better than expected. Higher Treasury yields can lessen the attractiveness of Utilities stocks, which tend to pay relatively high dividends, because investors can get similarly high yields elsewhere.

How we evaluate stock sectors for this outlook

We begin with a data-driven evaluation of each of the 11 equity sectors based on five factors—Growth, Quality, Sentiment, Stability and Value. Multiple data points are used in this analysis, including estimated and historical dividend growth, cash flow, revenue per employee, price momentum, analyst price target revisions, sales growth variance, trading volume turnover, change in short interest, and the forward price-to-earnings ratio, which divides the share price by the estimated future earnings of the company.

The sectors are then evaluated relative to the S&P 500 index to arrive at one of three preliminary ratings: Outperform, Marketperform and Underperform. Once confirmed, these ratings will reflect our view of how the sector is likely to perform relative to the S&P 500 during the coming six to 12 months.

The Schwab Center for Financial Research bases its ratings approval on a combination of the quantitative model and a qualitative perspective on what's happening in the economy and markets. For example, there may be times when the model points toward a rating based on recent data, but SCFR's experts have strong reason to believe that an economic, market or geopolitical shift is underway that would change the sector outlook. In that case, SCFR may override the model.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the S&P 500 allocations to each sector, listed in the Sector Performance chart above, as a guideline.

Investors who want to make tactical shifts in their portfolios can use Schwab Sector Views' Outperform, Underperform and Marketperform ratings as a resource. These ratings can be helpful in evaluating and monitoring the domestic equity portion of your portfolio.

Schwab clients can log into their accounts and use Schwab's Portfolio Checkup tool to help assess their sector allocations. If they decide to make adjustments, they can use the Stock Screener to research particular sectors. Schwab's ETF Screener and Mutual Fund Screener also can help identify funds that specialize in particular sectors. Investors and clients should consider this as only a single factor in making their investment decision while considering the current market environment.

Investors should consider carefully information contained in the prospectus, or if available, the summary prospectus, including investment objectives, risks, charges, and expenses. You can request a prospectus by calling 800-435-4000. Please read the prospectus carefully before investing.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed.

Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Investing involves risk, including loss of principal.

Past performance is no guarantee of future results.

Supporting documentation for any claims or statistical information is available upon request.

Diversification and asset allocation strategies do not ensure a profit and cannot protect against losses in a declining market.

Currency trading is speculative, volatile and not suitable for all investors.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Commodity-related products carry a high level of risk and are not suitable for all investors. Commodity-related products may be extremely volatile, may be illiquid, and can be significantly affected by underlying commodity prices, world events, import controls, worldwide competition, government regulations, and economic conditions.

Risks of the REITs are similar to those associated with direct ownership of real estate, such as changes in real estate values and property taxes, interest rates, cash flow of underlying real estate assets, supply and demand, and the management skill and creditworthiness of the issuer. Investing in REITs may pose additional risks such as real estate industry risk, interest rate risk, risks related to the uncertainty of and compliance with certain tax regime rules, and liquidity risk.

The information and content provided herein is general in nature and is for informational purposes only. It is not intended, and should not be construed, as a specific recommendation, individualized tax, legal, or investment advice. Tax laws are subject to change, either prospectively or retroactively. Where specific advice is necessary or appropriate, individuals should contact their own professional tax and investment advisors or other professionals (CPA, Financial Planner, Investment Manager) to help answer questions about specific situations or needs prior to taking any action based upon this information.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes, please see schwab.com/indexdefinitions.

Factors used in this report:

The Growth factor is based upon several historical (and forward-looking) growth rates of accounting variables and analyst-estimates. Stocks with high profitability growth, high expected dividend growth, and/or lower expected sales growth tend to have better Growth scores.

The Quality factor is built using various operating performance measures derived from financial statement data. Stocks with attributes such as high profitability, high earnings quality, conservative investment spending and/or better operating efficiency will likely have better Quality scores.

The Sentiment factor is calculated using measures of both long-term and short-term changes in investors' expectations. Stocks with recently improving analysts' outlooks, strong and consistent price performance, and/or optimistic trading positions and trends tend to score better within Sentiment.

The Stability factor is based on performance variability measures derived from both financial statements and trading data. Stocks with low sales volatility and low trading volume turnover tend to have better Stability scores.

The Value factor uses multiple value-oriented investment criteria. In general, stocks with attributes such as relatively high levels of free cash flow, operating income and expected future earnings tend to have better Valuation scores.

Sector definitions:

Communication Services sector: The Communication Services Sector includes telecom and media & entertainment companies including producers of interactive gaming products and companies engaged in content and information creation or distribution through proprietary platforms.

Consumer Discretionary sector: The Consumer Discretionary sector's manufacturing segment includes automobiles & components, household durable goods, leisure products and textiles & apparel. The services segment includes hotels, restaurants, and other leisure facilities. It also includes distributors and retailers of consumer discretionary products.

Consumer Staples sector: The Consumer Staples sector includes manufacturers and distributors of food, beverages and tobacco and producers of non-durable household goods and personal products. It also includes distributors and retailers of consumer staples products including food & drug retailing companies.

Energy sector: The Energy sector includes companies that operate in the areas of exploration & production, refining & marketing, and storage & transportation of oil & gas and coal & consumable fuels. It also includes companies that offer oil & gas equipment and services.

Financials sector: The Financials sector includes banking, financial services, consumer finance, capital markets and insurance activities. It also includes Financial Exchanges & Data and Mortgage REITs.

Health Care sector: The Health Care sector includes health care providers & services, health care equipment & supplies, and health care technology companies. It also includes companies involved in the research, development, production and marketing of pharmaceuticals and biotechnology products.

Industrials sector: The Industrials sector includes aerospace & defense, building products, electrical equipment and machinery and companies that offer construction & engineering services. It also includes providers of commercial & professional services including printing, environmental and facilities services, office services & supplies, security & alarm services, human resource & employment services, research & consulting services. It also includes companies that provide transportation services.

Information Technology sector: The Information Technology sector includes software and information technology services, manufacturers and distributors of technology hardware & equipment such as communications equipment, cellular phones, computers & peripherals, electronic equipment and related instruments, and semiconductors and related equipment & materials.

Materials sector: The Materials sector includes chemicals, construction materials, forest products, glass, paper and related packaging products, and metals, minerals and mining companies, including producers of steel.

Real Estate sector: The Real Estate sector includes companies engaged in real estate development and operation. It also includes companies offering real estate related services and Equity Real Estate Investment Trusts (REITs).

Utilities sector: The Utilities sector covers utility companies such as electric, gas and water utilities. It also includes independent power producers, energy traders and renewable sources.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

0524-5FXK

A message from Advisor Perspectives and VettaFi: Join us on June 27 for the Midyear Market Outlook Symposium, where advisors will gain insights into macroeconomic trends, active ETFs, investing abroad, and more to navigate 2024's challenges.