Here are the Leading Sectors to Watch in the New Year

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The new year is off to a mixed start, judging by the first few trading days of 2022. But it’s where the market winds up next New Year’s Eve that matters most to investors.

Looking at the fearless forecasts from some of Wall Street’s biggest investment firms, it’s anybody’s guess where the S&P 500 will close out 2022.

Oppenheimer has one of the most bullish forecasts of the big Wall Street firms. Its analysts see the S&P 500 ending this year at 5,330, up 13.5%.

At the bearish end of the spectrum lies Morgan Stanley. The firm’s top equity strategist sees the S&P 500 falling more than 6% over the next 12 months, to a year-end target of 4,400.

As for which sectors of the stock market offer the most upside, Wall Street analysts are, again, all over the map. After all, there are 11 sectors in the S&P 500 to choose from.

If you’ve been reading TradeSmith Daily for some time, you know our TradeSmith Finance tools focus on the health of individual stocks, sectors, and markets, looking at factors such as price trend, upside momentum, and strong fundamentals.

To take this one step further, I like to study a Relative Rotation Graph of the S&P 500 to see which sectors and stocks are leading the market and which are lagging, as well as which are improving in strength or weakening.

This analysis is based on a sector’s relative strength and price momentum compared to the S&P 500 overall. And here’s how the S&P sectors stack up right now.

Source: StockCharts.com
What you see above is a Relative Rotation Graph with each of the S&P 500 sectors. It quickly shows which sectors are leading the market and which are lagging. Plus, it shows you the sectors that are either improving or weakening relative to the index.

The best place to be is in the top-right (green) box. These sectors are leading the stock market. The bottom-right box (yellow) includes sectors that are weakening relative to the S&P 500. At bottom left (red), the worst place to be, are the sectors lagging the index. And finally at top left (blue) are the improving sectors that are gaining strength.

The black circle shows where the sector is now, and the colored tail shows where it has been in the last five weeks. Over time, the different sectors rotate in a clockwise motion through these phases. I like to focus on sectors that are leading. That’s especially true if they have just crossed from improving into a leading position. Meanwhile, you want to avoid sectors that are weakening, and especially those that are lagging.

Currently four sectors are in the “leading” box, at top-right: Materials (XLB), Real Estate (XLRE), Technology (XLK), and Consumer Discretionary (XLY). However, a closer look tells me the Technology sector looks like it may be stalling out. And Consumer Discretionary is quickly losing price momentum, as you can see by its sharp downward arc.

Both of these sectors are close to falling into the “weakening” box at bottom-right. That’s where the Energy (XLE) sector already is. So you might want to avoid adding new money to these sectors now, but keep a close watch on them.

The other sectors shown above are either lagging (bottom-left box) or improving (top-left box). That leaves Materials and Real Estate as the two most promising sectors now. Both recently crossed into the leading box from Improving.

They also both show rising relative strength compared to the S&P. Plus, they have strong price momentum. This bullish combination can often sustain these sectors as market leaders for many weeks or even months.

Now, peering slightly into the future, inflation and the possibility of rising interest rates are perhaps two of the biggest threats to the stock market in 2022.

The latest Consumer Price Index reading last month showed inflation of 6.8% year over year, the largest annual increase since 1982! The Federal Reserve is uncomfortable with accelerating inflation and is now more likely to raise short-term interest rates this year as a result.

In the past, when inflation is above 3% and rising, as it is right now, stocks tend to struggle, rising only 48% of the time over the next year.

Some sectors are better at protecting you from rising rates and inflation than others. And two of them are, you guessed it, Materials and Real Estate.

Materials excels because rising inflation increases the selling price of the commodities that companies in this sector produce, boosting their profits. Real Estate benefits directly from a higher inflation rate as property prices keep pace with inflation.

In fact, both sectors outperform the S&P 500 index (SPY) about 70% of the time when inflation is on the rise, as it is now.

But which real estate stocks are the best bets today?

Turning to our trusty TradeSmith Finance tools, you’ll see that 100% of the stocks in the Real Estate sector are in the Green Zone and in a healthy state.

Drilling a bit further into the stocks that make up the Real Estate Select Sector ETF (XLRE) shows that just over half (55%) have Strong Bullish ratings in our system.

Use our Screener tool to dig even deeper and find the real estate stocks with the highest rating of Strong Bullish and a dividend yield above 3%. That’s more than twice the average dividend yield of the S&P 500.

The Screener shows five stocks that have a rating of Strong Bullish and also yield more than 3%. When we sort these results by dividend yield, the best choice is Iron Mountain (IRM), a real estate investment trust (REIT) that yields 4.8% currently.

To uncover the best opportunities in the stock market, I like to keep an eye on which sectors and stocks are leading the market and which are lagging. By sticking with the leaders, you can help stack the odds of success in your favor. And our TradeSmith tools can help you do it.