Stock Market Sectors – Looking Under the Hood

Posted by Denis Smirnov

I got a lot of feedback on the post about Corporate Bonds. Related to that article, I wanted to post some of the work I’ve been doing analyzing stock market sector composition, how big each one is and what’s actually in them. It’s important to know what you are actually buying, be it Total Stock Market Index or Sector ETFs. I’ll use SPDR Sector ETFs (Spiders) for my analysis since they are the largest and most followed sector products on the market. Essentially they take the S&P 500 index and break out underlying 500 stocks (actual number is 505) into 10 component sectors.  Exhibit 1 shows SPDR sectors sorted by market size. It also shows some size stats based on market capitalization (#1 in each columns highlighted in green, #10 in orange). Technology is by far the largest sector and it only keeps growing relative to the rest of the market. The average market cap of its top 10 holdings is $412 billion or over two times that of the runner up Financials at $192 billion! Bottom three sectors are pretty small at 3%, but Utilities and Real Estate are still attractive to income investors.

Exhibit 1 – Sector Representation of the S&P 500 Index (as of 9/25/2017)

Now let’s dig into each fund to see what’s driving them. Exhibit 2 shows top 20 companies in each sector so you can see what you are actually buying when investing in these funds. Here are my random thoughts and observations on each sector:

Technology (XLK)

  • By far the largest sector, it is dominated by companies with market caps of hundreds of billions
  • Note that due to sector classification rules, there are some large companies that are not included in this ETF even though most people would consider them technology outfits – Amazon.com ($450bn), Priceline ($90bn) & Netflix ($77bn) are all included in Consumer Discretionary.
  • Also beware that the granddaddy of them all – $800bn Apple – is sometimes classified as Consumer company by some other classification methods (although SPDR does include it in tech).
  • Google’s dual share classes make things a bit confusing and can lead to double-counting it
  • There are some companies I wouldn’t consider tech here – telcos AT&T/Verizon and payment networks Visa/MasterCard (I guess PayPal too?)
  • And look at the market darling NVDA moving up in the world. Its market cap doubled from $50bn just this year alone. And it was just $15bn in January 2016! VR and self-driving cars are good for it…

Financials (XLF)

  • Warren Buffet is the man!, although calling Berkshire a Financial is a stretch these days as he’s buying up everything from railroads to utilities and industrials.
  • Mega-banks are still “too big to fail” and getting bigger. Although watch the blockchain disruption here (not Bitcoin, but it’s underlying technology)! Jamie Dimon has a vested interest in poo-pooing it.
  • Investment banks and asset management companies are well-represented too, as are various insurers
  • Credit rater S&P Global didn’t miss a step despite being less than helpful during the financial crisis

Healthcare (XLV)

  • Pharma, biotech and health insurer consolidation has created some big players here! It’s a tough sector and scale is important.
  • We’ll probably continue to see deals in this space as the big guys buy promising drugs to build up pipeline.
  • Also, depending what happens with Obama/Trump care, there might be some shakeout in health insurance.

Consumer Discretionary (XLY)

  • What a mish-mash this is. And likely to look very different in 5-10 years as fickle consumer tastes change. Cable TV, retail, non-electric cars and fast food sure look like dinosaurs!
  • Note that despite having larger market cap than GM and Ford, Tesla is not included in the S&P 500 index.

Industrials (XLI)

  • Despite the name, Defense & Transports rule here.
  • Among transports rails are big, but the first airline doesn’t appear until #24 with Southwest Air at $32bn market value (it pays to be good to your customers!)

Consumer Staples (XLP)

  • Soda pop & cigarettes – enough said!
  • At some point the growing health-consciousness in the U.S./Europe will catch up with these guys, but then there is always Third World consumers to go after.

Energy (XLE)

  • Used to be MUCH bigger sector but years of sliding oil/gas prices do wonders to realign capital flows, let Capitalism work!
  • Remember when Exxon was bigger than Apple? Ha, how cute 🙂

Utilities (XLU)

  • Boring stuff, but that’s the way in should be. Can’t get too big with regulatory oversight.
  • When interest rates actually do go up, it’ll be interesting to see how this sector handles investor shift.

Real Estate (XLRE)

  • This sector was part of XLF until it was broken out into a separate one on September 1, 2016.
  • There’s been some reshuffling here with Retail REITs hurting and various Specialties doing better.

Materials (XLB)

  • All kinds of companies here, from chemicals to miners, from packaging/paper to building materials.
  • Despite sounding boring, some of these guys fly during particular market periods. As far as I’m concerned, it’s just another good reason to use broad indices.

 

If you are interested in how sector weights have changed over time, Bespoke has some cool analyses here.

Exhibit 2 – Top 20 Companies by Sector (as of 9/25/2017)