U.S. equity markets are grappling with the highest inflation in decades, critical central bank policy decisions, and slowing economic growth. This challenging set of macroeconomic factors has caused dispersion in different equity sectors, which in turn has created trading opportunities for investors looking to manage sector-related risk.
During volatile periods like today, sector futures can be a useful tool because they provide the ability to go short or long. Highlighted below are examples from the CME Group suite of sector futures available to address some of the most active sectors of 2022. While the macro environment will inevitably evolve in 2023, market participants can learn from the recent trends and utilize sectors as investment tools in their portfolios during times of uncertainty.
One way to observe trends in differing sectors is to look at each index’s dispersion. The dispersions charted below illustrate the significant opportunities available to traders who want to tailor their risk and exposure by sector, rather than simply trade the parent S&P 500 index. In this case, dispersion is a measure of how volatile the price of each sector index has been since the start of the year. Dispersion, therefore, provides a benchmark of how each sector has fared during 2022, and it is important to consider how this may develop in 2023.
Energy Stocks Had a Strong Year
As illustrated above, if we are ranking the magnitude of dispersion, the energy sector wins the top prize. Energy’s positive dispersion can be attributed to the outperformance of energy stocks this year, which has propelled the S&P Energy Select Sector Index to be up over 60% through November. In stark contrast, the S&P 500 is down around 15% year-to-date. The difference in index returns demonstrates the usefulness of trading sectors for an investor looking to tailor their exposure and take advantage of sector-specific trends, which can be overshadowed in a broad-based parent index, like the S&P 500.
As of November 30, 2022, CME Group’s E-mini S&P Energy Select Sector Futures volumes were up around 30% year-to-date compared to the same time period in 2021, demonstrating this year’s increased need to hedge energy-related risks. Using sector futures, a participant can capture market opportunities in sectors, like energy, as well as protect against potential losses in underperforming sectors, which ultimately facilitates a more thematic portfolio approach. While the energy sector has been the star performer in 2022, sectors like real estate and technology have suffered significant hurdles.
Real Estate and Tech Sectors Down
Mortgage rates are at their highest levels in years, and the phenomenon of rising rates is manifesting a slowdown in the housing market. Additionally, the real estate market has had to battle commercial property declines, and the commercial real estate investment trusts (REITs) in the index have contributed to the year-to-date decline of 26% in the S&P Real Estate Select Sector index. While inflation is showing signs of moderating and interest rate hikes are potentially tapering off, the real estate market is likely to continue experiencing volatility whether these phenomena persist or reverse course. CME Group lists two different real estate sector futures, E-mini Real Estate Select Sector Futures and Dow Jones Real Estate Futures, giving participants multiple opportunities to manage their real estate exposure.
Technology stocks have also suffered in recent months after experiencing heightened levels at the start of the pandemic. The S&P Technology Select Sector index is down around 25%, with big names like Alphabet, Microsoft, and Meta all losing over $2 trillion in combined market capitalization since the start of this year.
Additionally, the semiconductor market has experienced volatility since the start of the pandemic, between chip shortages and disrupted supply chains, providing some context to its steadily negative dispersion shown in the chart below. The performance of semiconductors is yet another example that highlights the theme of sector dispersion and why futures can be a useful tool in managing these varying risks. The six sectors shown in the chart below were recently introduced as sector futures to provide investors greater flexibility in increasingly popular economic sectors.
The sector story of 2022 points to an increased need to manage sector-specific risk, and sector futures are one way to do so. CME Group offers 19 different sector futures, including E-mini Select Sector, Select Industry, Dow Jones Real Estate, and PHLX Semiconductor Sector futures.
An important recent development in the sector futures suite is the introduction of Derived Blocks, which are available to trade on all CME Group sector futures. A derived block is a block trade in which the price and quantity of the trade depend on hedging transactions in an eligible related market. This new trading functionality allows clients to source liquidity from a related market and thus helps facilitate the intraday execution of larger orders. In addition to being traded via derived blocks, CME Group’s sector futures can be traded outright on CME Globex, as outrights, blocks, and via Basis Trade at Index Close (“BTIC”), which allows participants to trade against the closing underlying index value.
A new year brings new market phenomena. However, as 2022 reminded us, uncertainty is ever-present in equity markets. Watching individual sectors rather than only broad index performance can highlight risks and opportunities for investors, and can help them manage risk accordingly.
