Sector Leaders in Volatile Times

Which groups have posted the best and worst performances following market tumult? Here's a guide

by Sam Stovall From Standard & Poor's Equity Research

Changes in volatility

Sector performance following periods of volatility

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On Feb. 27, the S&P 500 index declined 3.6%, and thereby snapped the string of 949 days without a one-day price decline of 2% or more—the longest run since January 3, 1950. This "death of docility" leads to the question: What happened to the S&P 500 and its sectors/industries in the period after?

As seen in the accompanying table, the volatility increased, as the S&P 500 posted an average of five occurrences of one-day declines of 2% or more in the 12 months following the first 2% decline in more than a year. Also, the average daily volume increased 9% in the following year, while the standard deviation of daily price changes widened by 33%.

Most important, in our opinion, was the fact that the S&P 500 gained an average 5%, 5%, and 7%, respectively, in the ensuing three, six, and 12 months following the initial 2% slump. But such consistency wasn't the rule. Twice in the first three months, and three times in the following six- and 12-month periods, the S&P 500 posted declines from 1% to 14%, whereas the market advanced a minimum of five times, anywhere from 2% to 27%, and averaged mid-single-digit gains.

In other words, while one might have thought that investors would either have chosen to tread carefully following sharp declines or else look upon the pullback as a buying opportunity, there didn't appear to be a consistent type of follow-through.

Standard Sector Leadership In the six months following the beginning of the eight periods of heightened volatility, some of the usual suspects (the defensive sectors of the market) posted the strongest returns and frequencies of market outperformance. Yet others were conspicuous by their presence or absence. Take a look at the accompanying table.

The average advance for the industries that were in existence since 1959 (there were no sector-level indexes prior to 1989) was greatest in Health Care, gaining an average 8.5%, followed by Financials, with an average advance of 7.8%, and then Consumer Staples, with an average gain of 4.8%, as compared with an average increase of 4.5% for all industries that participated in this study.

Financials was a bit of a surprise for me, but maybe it shouldn't have been when you consider their high dividend yield and concentration of high quality issues (component companies with S&P Quality Rankings of A– or better). Surprisingly, Utilities were only a market performer, possibly due to the lack of high quality component companies.

On a subindustry level—the groups listed here are called "old" since they predate S&P's Global Industry Classifications Standard (GICS) started in 1989—the list is also a bit inconsistent. Instead of the best performers being predominately from the Consumer Staples and Health Care sectors, the leaders on an average price change and frequency of outperformance basis came from Financials, Industrials, Materials, and Consumer Staples. The laggards came from the Consumer Discretionary, Industrials, Information Technology, and Materials Sectors.

So there you have it. While I believe that history can be a good guide (but never gospel) in assuming that the market's volatility will increase in the year ahead, I wouldn't spend too much time attempting to divine which subindustries will be standing in the victory circle a year from now. Instead, I would focus more on the fundamental outlooks (and S&P STARS) to pick the winners.