Comment: Which sectors are driving the S&P 500 higher?

By Ipek Ozkardeskaya

The S&P 500 is testing uncharted territory as it continued to trend higher on the Trump reflation trade. Although Donald Trump proved to be less than efficient in turning his major policy plans into concrete action, including the highly anticipated tax reforms, that failed to dampen nvestor optimism.

Financials run out of steam

A quick glance at the S&P500's sector dynamics reveals that financials have been the most reactive to the lack of momentum from the Trump administration.

Big US banks and financials outperformed the S&P 500 index immediately after Donald Trump was elected President of the United States in November.

Shares in the country's top lenders skyrocketed on expectations that the Federal Reserve would raise rates faster than otherwise to offset Trump’s expansive fiscal projects.

Lately, there has been a correction to the upbeat expectations in financials' earnings.

For the first quarter, earnings surprised investors on the upside by 2.30%, just behind mining stocks, which beat analysts' expectations by 3.81%. This being said, those previous expectations proved well-founded; the Fed has already hiked the Fed funds rates by 50 basis points and is expected to proceed with an additional 50 basis points of tightening before the end of this year.

However, inflation expectations have been broadly revised down as Donald Trump has not been successful in bringing all his plans to life. In fact, only a tiny part of the plans were approved.

Massive infrastructure spending and major tax cuts are still to be agreed with Congress and Fed officials seem gradually less concerned about the risk of an eventual Trump-induced economic thunderstorm.

As such, the gap between financials' valuation and the rest of the S&P500 has narrowed gradually since the beginning of March.

The potential for financials seems to be exhausted in the present circumstances and the sector retraced to the all-sector average with sentiment now neutral.

Industrials stagnate

Industrials and miners have been boosted by Trump's promises and a couple of executive orders signed off as soon as Donald Trump took the reins of the US executive branch.

Mining companies’ earnings soared as commodity prices rose steeply on the ‘Trump-reflation’ theme.

Yet, industrial stocks failed to pick-up extra momentum and have put in just an average performance since the beginning of the year.

Healthcare stocks in wait-and-see mode

Healthcare stocks have been volatile due to the Obamacare repeal and replace plans, one of the Republicans' major preoccupations and one of the major headaches of the new Trump administration. As contradictory news hit the wires, many investors moved to the sidelines.

Although inflows into healthcare stocks improved following the knee-jerk negative reaction in November, investors are still in wait-and-see mode. Obamacare will likely continue to be a major headache for President Trump.

Although the US House managed to pass the bill on a second attempt, the bill will likely meet solid resistance in the Senate. All US health organisations are against the new plan.

Energy boost could be limited

The energy sector, which has underperformed all other sectors, is set for a recovery after hitting bottom earlier this month. The OPEC-Russia agreement on extending their output cuts for an additional nine-months and the recent decline in US oil inventories should encourage further capital flows into energy stocks, as long as oil prices keep climbing.

Nonetheless, it is important to highlight that the energy sector remains vulnerable to an eventual pullback in energy prices which could immediately dent investor appetite for the group.

Tech stocks the shining stars

The real winner in the aftermath of the US election has been the technology sector. Information technology stocks have been gradually trending higher and have the potential to continue outperforming their peers. There are three leading factors among many others that explain Wall Street's romance with IT stocks.

First, the IT sector is the world’s fastest growing sector with unlimited potential to extend its limits, while the rest of the sectors usually have a known and limited potential.

Second, IT companies are believed to be less sensitive to the changing political environment.

Finally, it is well possible that in contrary, the new restriction imposed on the US companies could benefit the IT sector by improving their investment in R&D and innovation.

In fact, companies will eventually increase their IT investment allocations to diminish a part of the additional costs caused by the new limitations in terms of localisation, expressly delocalisation.

Author Ipek Ozkardeskaya is a senior market analyst at London Capital Group