One of the ways you can quickly identify stocks and ETFs that are likely to outperform in the coming months is by using a relative performance line. This simple, effective method can greatly increase your investment wins in an otherwise challenging market environment. Using this technique, let’s look at some of the strongest sectors and industries entering 2023.
Relative performance (RP) is simply a measure of how well a stock or ETF is doing compared with the S&P 500 Index. An RP line can be constructed using StockCharts.com or other charting software by dividing a stock’s price by the S&P 500 index on a daily basis. The resulting number is plotted as a continuous line and shows how well the stock in question is performing versus the broad market.
Stocks and sector ETFs that are showing relative strength versus the S&P are more likely than not to continue outperforming based on the well-known observation that “a trend in motion tends to stay in motion.”
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Moreover, RP is a vitally important tool in a bear market since outperforming stocks are usually in strong hands (i.e. owned by informed investors), with the assumption that uninformed small investors are less likely to own such stocks in a persistently weak environment. This in turn decreases the likelihood that RP leaders will be heavily sold off during broad market declines.
Here is a list of what I consider the five best-performing sectors relative to the S&P 500 as 2022 draws to a close. We’ll start this review with the lowest RP ranking and work up to the highest ranking.
Strongest Sector #5: Energy
Starting off the list, honorable mention goes to the energy sector which appears to be turning a corner after basically treading water the last few weeks. The relative performance line for the Energy Select Sector ETF (XLE) has just crossed above the 50-day moving average after being under it since late November. This suggests oil and gas stocks are returning to a position of relative strength entering the new year (in part due to China’s emergence from its Covid Zero policy that should increase global energy demand).
Strongest Sector #4: Financials
Bank stocks also look to be strong performers in 2023, thanks in part to higher interest rates (which increase banks’ profit margins). The Financial Select Sector ETF (XLF) is outperforming versus the S&P and is also currently above the rising 50-day line, as shown here. With the Fed signaling that it’s not yet done raising rates, an increasingly strong financial sector looks like a good bet for the new year.
Strongest Sector #3: Consumer Staples
One of the market’s strongest performers is the consumer staples sector, which is a defensive-oriented space that investors typically turn to in uncertain times. Unsurprisingly, the consumer staple stocks have been among 2022’s best performers, and with investors increasingly worried about a recession, this group is likely to remain strong in the months ahead. The chart below compares the Consumer Staples Select Sector ETF (XLP) with the S&P. As long as this RP line is trending above the 50-day MA, having some exposure to consumer staples stocks or ETFs is warranted.
Strongest Sector # 2: Industrials
Coming in at second place is the industrial sector, which has shown notable relative strength for much of 2022. This is reflected in the RP line for the Industrial Select Sector ETF (XLI), which is well above its rising 50-day moving average. Despite a tepid economic backdrop, nonresidential and industrial construction projects in the U.S. are proceeding at a torrid pace, thanks to recently passed federal legislation supporting infrastructure development. This is just one of the reasons why the industrial sector looks to be one of 2023’s strongest performers.
Strongest Sector #1: Health Care
After underperforming for much of last year, healthcare stocks (drug and device makers and the like) have hit a bullish stride entering 2023. The RP line for the Health Care Select Sector ETF (XLV) highlights the remarkable turnaround in this sector in recent months, and with this indicator above the 50-day moving average as we exit 2022, it serves as a further commendation of this space. U.S. healthcare spending is conservatively projected to grow at a rate of 7% over the next five years, providing a strong fundamental backdrop for the sector. What’s more, healthcare typically outperforms during periods of high inflation, which is one of many reasons for expecting the sector to maintain strength in the new year.
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