Schwab Sector Views: There’s a New Sector Coming

Schwab Sector Views is our three- to six-month outlook for 10 stock sectors, which represent broad sectors of the economy. It is designed for investors looking for tactical ideas. We typically update our views every two weeks.

The S&P 500® index has been divided into 10 sectors for quite some time—but that’s all about to change. At the beginning of September, real estate will become a shiny, brand-new 11th sector.

A quick reminder: Since its inception in 1999, the Global Industry Classification Standard, or GICS®—the most widely used sector categorization system, published by Standard & Poor’s and MSCI—has considered real estate a part of the financials sector. However, S&P and MSCI have determined that the real estate group should be spun out from the financial sector and get its own heading. They’re not adding companies that weren’t in the S&P 500, they’re shifting companies—28 to be exact, according to S&P—from financials to real estate.

The majority of the new sector will be made of equity real estate investment trusts (REITs), with some real estate development companies included. Equity REITs are companies that own physical property and typically receive some sort of rental income. Included in this group are companies that own such things as apartments, office property, malls, storage, etc. So-called mortgage REITs, which purchase mortgages as opposed to actual physical property, will not be included in the new sector and will remain in the financial sector.

So what should investors do?

Not much—at least for now. Depending on the investments that investors hold, they may have to adjust allocations once the dust settles a bit, but investors that hold mutual funds or certain exchange-traded funds (ETFs) may have the adjustments done for them. There isn’t a huge amount of urgency here, and the actual change doesn’t take place until the beginning of next month. Nevertheless, over the next couple of months it would be a good idea to determine what your funds did, and then determine what you may need to do to add or subtract to real estate exposure. At this point it looks like the new sector will make up about 3% of the S&P 500—not insignificant, but certainly not a major percentage.

Then what’s our view?

When we update our ratings after September 1, we anticipate that our first rating of the real estate sector will be marketperform, while financials will remain at outperform. To be sure, the equity REIT group has had a nice run, with the MSCI US REIT Index rising roughly 13% in 2016 through the middle of August. This group has benefited from a sort of perfect storm: Low interest rates have allowed them to obtain cheap financing, while also attracting investors who are searching for income. Incidentally, The Wall Street Journal reported that the dividend yield of the financial sector will drop by about 25 basis points (from roughly 2.25% to 2%) with the removal of equity REITs. Additional benefits have come to the group from a steadily improving economy and an increasing demand for apartments from folks that have been unwilling or unable to jump back into the housing market after the financial crisis..

But we think it’s getting a little late in the game to aggressively jump into this group. In fact, if you have more than the market percentage allocated to REITs, it may be time to pare holdings and take some profits. U.S. interest rates seem more likely to rise than to fall over the next couple of years. Additionally, the laws of supply and demand are taking hold, as we often see in the real estate area. For example, we’ve seen apartment-building rise precipitously, coinciding with a rise in rents.

Apartment supply is increasing

Source: FactSet, U.S. Census Bureau. As of Aug. 16, 2016.

Which could affect the rate of rent increases

Source: FactSet, U.S. Census Bureau. As of Aug. 16, 2016.

We’ve had a theory for a while now that while Millennials have been different from previous generations in many ways, we think they will start to follow their elders by moving away from apartments and into houses. Apartments start to become less attractive to many when a couple of kids are added, or folks start to pay attention to all that rent they’re paying without building up any equity. According to a study by University of Southern California demography and urban planning professor Dowell Myers, we are in fact starting to see Millennials move from apartments to houses—delayed perhaps, but not denied!

Although in this instance we think Millennials will follow their parents to some extent, we believe parents are following their kids in another—shopping. We’re seeing more and more online purchases being made, which is hurting traditional mall-based retailers—and could start to hurt the rental rates malls can charge to their tenants.

Sliding department store sales could affect mall rent

Source: FactSet, U.S. Bureau of Economic Analysis. As of Aug. 16, 2016. 

Now, we don’t think either of these markets is falling apart, but we do think the gains will start to moderate. So we believe a market allocation will be appropriate, and will likely have that recommendation in our table below, and in the more detailed sector analysis that will be added after the first of the month. And for investors that want to buy individual REITs, it is important to do the research on the holding of that REIT and the viability of the cash flows coming into the company for the foreseeable future.

Schwab Sector Views: Our current outlook

Sector

Schwab Sector View

Date of last change to Schwab Sector View

Share of the
S&P 500 Index

Year-to-date return as of 08/02/2016

Consumer discretionary

Marketperform

07/17/2014

12%

5.37%

Consumer staples

Marketperform

05/07/2015

10%

9.72%

Energy

Marketperform

11/20/2014

7%

16.54%

Financials

Outperform

05/07/2015

16%

1.63%

Health care

Marketperform

12/13/2012

15%

3.99%

Industrials

Marketperform

01/29/2015

10%

11.12%

Information technology

Outperform

04/29/2010

21%

9.58%

Materials

Marketperform

01/31/2013

3%

12.82%

Telecom

Underperform

09/12/2013

3%

21.10%

Utilities

Underperform

05/23/2013

3%

16.42%

S&P 500®  Index (Large Cap)

 

 

 

8.06%

Source: Schwab Center for Financial Research and Standard and Poor's as of 07/29/2016.

Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations.

What is Schwab Sector Views?

Schwab Sector Views is our three- to six-month outlook for 10 stock market sectors, which are based on the 10 broad sectors of the economy.

The sectors we analyze are from the widely recognized Global Industry Classification Standard (GICS) groupings. After a review of risks and opportunities, we give each stock sector one of the following ratings:

  • Outperform: Likely to perform better than the rest of the market.
  • Underperform: Likely to perform worse than the rest of the market.
  • Marketperform: Likely to track the broad market.

How should I use Schwab Sector Views?

Investors should generally be well-diversified across all stock market sectors. You can use the Standard & Poor's 500 allocations to each sector, listed in the chart above, as a guideline.

Investors who want to make tactical shifts in their portfolio 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 Sector Views can also be useful in identifying stocks by sector for potential purchase or sale. When it's time to make adjustments, Schwab clients can use the Stock Screener or Mutual Fund Screener to help identify buy or sell candidates in particular sectors. Schwab Equity Ratings also can provide an objective and powerful approach for helping you select and monitor stocks. 

Next Steps

Talk to Us
To discuss how this article might affect your investment decisions:
-          Call Schwab anytime at 877-338-0192.
-          Talk to a Schwab Financial Consultant at your local branch.

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