Fisher Investments Puts Stock Sector Leadership Rotation in Context

Technology has been the top-performing stock market sector over the past decade. With that kind of streak, some might think the good times will last forever—especially with all the new, exciting developments in the space. For now, we expect Technology outperformance to continue. But before penciling in another long stretch of Technology leadership ahead, remember: No one sector is best for all time—a reason to be diversified and manage your portfolio actively, in Fisher Investments’ view.

Despite its strong run in recent years, Technology hasn’t always been the best. Based on the S&P 500’s sector returns by decade since 1990, it was the best during the 1990s and 2010s. But it was also the worst from 2000 to 2009—and that wasn’t just related to the Technology bubble’s bursting, as we will explain. Or take Energy, the S&P 500’s best sector year-to-date through October. It was worst in the 2010s—the only sector without triple-digit returns. But Energy did best from 2000 to 2009, right after delivering the third-worst return during the 1990s. Financials’ statistics over the past three decades show less-dramatic—but still noticeable—sector leadership shifts. It ranked third-best in the 1990s, third-worst in the 2000s and around the middle—6th out of 11—in the 2010s.

The reason a sector doesn’t lead forever, in Fisher Investments’ view, goes back to stock supply and demand. When a sector is in favor, investors notice and want to participate in the rise. They become more willing to pay more for shares, bidding prices higher. Those rising prices motivate firms in the sector to go public and sell shares to take advantage of the heightened demand. But this dynamic doesn’t hold forever. Frequently, share supply overshoots demand—causing prices to fall and leadership to break down. Stock supply exceeding demand is one reason bear markets (fundamentally driven downturns of -20% or more) occur.

On the demand side, in the aftermath of a bear market, Fisher Investments finds investors often “fight the last war”—i.e., they often punish the sectors that were at the center of the prior bear market. Initially, the sector that led the downturn tends to bounce back big in the new bull market. But it is fleeting and, after that early recovery, the sector often lags—sometimes for years. We think this is because the memory of the recent bear market is fresh, so investors take the sector’s problems—no matter how small—and extrapolate them into a big negative capable of repeating the downturn.

The most prominent example of this: Technology, following the dot-com crash in 2000. In the late 1990s, Technology began outpacing the broader index. From October 8, 1998 to the bull market peak on March 24, 2000, Technology soared 246.9%, far ahead of the S&P 500’s 62.2% over the same period. After the bubble popped, Technology was the worst-performing sector during the 2000–2002 bear market, falling -82.3%. While it did rebound sharply off that bear market low, that surge didn’t last, and from January 16, 2004 through the rest of the bull market that ended in October 2007, Technology’s 24.4% trailed the S&P 500’s 47.0%.

Financials plotted a similar post-bear market path. Starting in mid-2006, Financials led the S&P 500 (38.1% to 34.6%) before hitting its high on June 1, 2007—several months before the broader market peaked. The sector plummeted -81.7% during the 2007–2009 bear market. Like Technology after 2002, it also jumped off the bear market’s low—a run that didn’t last. That burst petered out around February 2011, and for the rest of the decade-long bull market, Financials’ 165.9% return trailed the S&P 500’s 268.1%.

Energy didn’t follow this exact pattern following the 1980–1982 bear market, but the upshot was similar. Starting in mid-1979, the sector began surging, ending up 137.3% to the S&P 500’s 53.2% before the Energy bubble popped in November 1980. Energy stocks led the way down, but when a new bull market began in August 1982, it didn’t experience a big rebound off the bottom. Instead, Energy underperformed the S&P 500 for most of the 1982–1987 bull market, with its 128.0% return trailing the S&P 500’s 162.0% from July 1982 to August 1986. Though Energy outperformed in that bull’s final stretch, rising 77.3% to the S&P 500’s 44.4% from July 1986 to August 1987, it spent the majority of that bull market lagging the broader index.

Sector leadership rotations look obvious in hindsight, but in the moment, they aren’t. To mitigate risk, Fisher Investments thinks it makes sense to be diversified. Now, diversification doesn’t mean splitting up your portfolio into equal weightings to each stock sector. Instead, we think it makes sense to use a benchmark index—e.g., the S&P 500 for US markets or the MSCI World for global markets—to guide your stock weightings. Your weighting to any one sector shouldn’t veer far from its weighting in the index, in our view. If there are areas of the market you think will likely do well, overweight them, but not by too much. For example, if you think the Technology sector will do well, you can increase your portfolio’s Technology weighting relative to your benchmark index. However, we think a core tenet of successful long-term investing is knowing that you could always be wrong. To address this, Fisher Investments believes investors should also have exposure to other sectors just in case they outperform instead—the essence of diversification. That could mean you own some Industrial stocks even if you think the sector will trail broader markets. You may be underweight relative to your benchmark, but you still have some exposure to the sector.

Since no crystal ball exists foretelling sector leadership, a diversified approach is a sensible way to manage risk, in Fisher Investments’ view.

Investing in stock markets involves the risk of loss and there is no guarantee that all or any capital invested will be repaid. Past performance is no guarantee of future returns. International currency fluctuations may result in a higher or lower investment return. This document constitutes the general views of Fisher Investments and should not be regarded as personalized investment or tax advice or as a representation of its performance or that of its clients. No assurances are made that Fisher Investments will continue to hold these views, which may change at any time based on new information, analysis or reconsideration. In addition, no assurances are made regarding the accuracy of any forecast made herein. Not all past forecasts have been, nor future forecasts will be, as accurate as any contained herein.