Schwab Sector Views is our three- to six-month outlook for stock sectors, which represent broad sectors of the economy. It is published on a monthly basis and is designed for investors looking for tactical ideas.
The Russian invasion of Ukraine in late February, and the ongoing political response, has clouded our outlook on equity sectors. Due to the unprecedented and volatile series of events, the economic and market landscape has become highly uncertain.
Until there is more clarity on how the sharp rise in commodity prices, tightening of financial conditions, and likely Federal Reserve interest rate hikes might impact the economy and underlying fundamentals that drive relative sector performance, we think it’s prudent to maintain sector allocations that are in line with the overall market. Therefore, we’re returning the Financials and Health Care ratings to neutral from outperform, as well as moving the Industrials and Materials ratings to neutral from underperform.
Commodity prices have surged
Prior the Russian invasion of Ukraine, there were already imbalances in the commodities market that drove prices to record highs, in some cases. The massive stimulus—both monetary and fiscal—spurred demand for commodities to the extent that supply could not keep up. This became worse as many commodity producers—particularly those in the oil and gas industry—held back production amid higher wages, surging transportation costs, and worries about a sudden reversal in prices as has happened during previous commodity price spikes. When Russia—the world’s largest exporter of oil—attacked Ukraine, the international community responded with harsh sanctions. While the first salvo of sanctions were designed to cut Russia off from the global financial system and avoid affecting their oil exports, many refineries and energy traders refused to buy Russian oil due to the risk of inadvertently violating those sanctions, as well as in solidarity with Ukraine. Outright embargos of Russian oil imports by the U.S. and other countries cemented the boycott by the private market.
Oil is not the only commodity being affected. Russia is also a major exporter of wheat, as well as natural gas, metals, and fertilizer. Along with these, prices of most commodities have surged—with few indications as to when traders’ fears and demand for those commodities will subside or the geopolitical firestorm will ease. This is likely to continue to result in outsized and rapid fluctuations in commodity prices, making it even more difficult to hold views on sectors influenced by them—such as Energy and Materials.
Prices are up sharply for most commodities
Source: Bloomberg as of 3/9/2022.
The S&P GSCI Energy, Agriculture and Industrial Metals Indexes provide investors with a reliable and publicly available benchmark for investment performance in the energy commodity market.
Financial conditions are in flux
As is the case with most major events—whether they be market, economic, or geopolitical—investors, borrowers, and creditors are compensating for higher risks by reallocating to safe-haven securities, raising cash and/or charging more to take risk—all of which can reduce liquidity and tighten financial conditions. This is being compounded by the likelihood that the Federal Reserve is about to begin raising short-term interest rates to ease demand and tamp down inflation. Its goal to navigate a soft landing in the economy has only become more challenging—raising the risk of a policy mistake that either fails to tame inflation or puts the economy into a recession. Until we have more clarity on the Fed’s chances for success, forecasting interest rates and the impact that could have on sectors—such as Financials and the REITs that make up the bulk of the Real Estate sector—is much more difficult.
Financial conditions have tightened
Source: Bloomberg as of 3/9/2022.
The Bloomberg U.S. Financial Conditions Index tracks the overall level of financial stress in the U.S. money, bond, and equity markets to help assess the availability and cost of credit. A positive value indicates accommodative financial conditions, while a negative value indicates tighter financial conditions relative to pre-crisis norms.
The impact on the economy is uncertain
Prior to the invasion, we were already seeing some slowing in the rate of economic growth—though the risk of recession remained low. However, the energy crisis is likely to continue to weigh on business conditions amid rising input costs and tighter financial conditions. And although the job market remains very strong, consumer confidence has plummeted, which threatens consumer spending—particularly as wage gains are being more than offset by surging inflation. While it’s unlikely that we’ll experience 1970s-style stagflation, the risk of a recession has increased. This argues for leaning into defensive sectors, such as Health Care, Utilities, and Consumer Staples. However, with a lot of investor anxiety likely already priced into the markets, any positive developments in the Russian war—even if fleeting—could precipitate a very strong rally in the markets, in which case the defensive sectors could sharply underperform.
Economic sentiment has deteriorated
Source: Bloomberg, Federal Reserve as of 3/9/2022.
The Federal Reserve Daily News Sentiment Index is a high frequency measure of economic sentiment based on lexical analysis of economics-related news articles.
Eventually, these issues will resolve themselves. But in the meantime, the markets are likely to be very volatile as investors try to make sense of the unprecedented confluence of these global geopolitical and macroeconomic events. We’re likely to see surges of relief that quickly unwind the frenetic responses to the crisis, potentially followed by renewed uncertainty. It’s never easy to forecast the relative performance of sectors, but in the current environment it is particularly challenging. Accordingly, we recommend investor align their sector allocations in line with those of the overall market.
What do the ratings mean?
* As represented by the S&P 500 index.
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 broader stock market*
- Underperform: likely to perform worse than the broader stock market*
- Neutral: no current view on likely relative performance
Want to learn more about a specific sector?
- Communication Services
- Consumer Discretionary
- Consumer Staples
- Health Care
- Information Technology
- Real Estate
Click on a link below for more information or visit Schwab Sector Views to see how they compare. Schwab clients can log in to see our top-rated stocks in each sector.
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® Index allocations to each sector, listed in the chart above, as a guideline.
Investors who want to make tactical shifts in their portfolios can use Schwab Sector Views' outperform, underperform and neutral 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. Clients can use the Portfolio Checkup tool to help ascertain and manage sector allocations. 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 a fact-based and powerful approach for helping you select and monitor stocks.