Although we don't believe in timing the market or panicking over daily movements, we do like to keep an eye on market changes -- just in case they're material to our investing thesis.
The S&P 500 (SNPINDEX:^SPX) lost about 3.6% in January, with broad-based declines in the majority of stocks in the index. Out of the major sectors in the S&P, only two managed to post gains. Yet even more surprising than the fact that two sectors overcame such heavy headwinds to climb was which sectors did well. As it turned out, the winning sector in the first month of 2014 was the utility sector, as SPDR S&P Utilities (NYSEMKT:XLU) ended January with a 3% gain. Health-care came in a distant No. 2, as SPDR Select Health-Care (NYSEMKT:XLV) gained just under 1%.
The big bond surprise
For utilities, the explanation for the sector's strong performance is obvious: interest rates defied expectations by falling substantially. Coming into 2014, most analysts expected 2013's big jump in rates to continue, with the Federal Reserve having signaled its intent to reduce its artificial influence on long-term interest rates by cutting back on its bond-buying activity. Yet even as the taper took hold, the poor performance in stocks left investors little choice but to retreat to bonds.
Traditionally, utility stocks have traded in a highly correlated way to bonds. Utilities tend not to be high-growth businesses, relying largely on established customers and benefiting from solid but unimpressive profit margins that in many cases are subject to regulatory oversight. Typically paying high dividends, utility stocks resemble bonds in their lack of growth prospects yet dependable income, and so they often trade that way. So as bonds gained in price in January, so too did utilities, with Exelon's (NYSE:EXC) nearly 6% gain being at the upper end but still representative of the industry as a whole.
Health-care stocks' strong performance is a bit more surprising, but to understand, it's helpful to look at which health-care stocks did well. Health-insurance providers did not fare well, as lingering concerns about the Affordable Care Act continue to weigh on the industry.
But several areas in health care showed strength. On one hand, large pharma stocks like Merck did well for many of the same reasons as utility stocks: their high dividends and growth challenges made investors treat them like bond alternatives, and strength in bonds led to strength in those stocks. At the same time, though, higher-growth biotech and development-stage pharma stocks also had strong performance, with 2013 outperformer Gilead Sciences (NASDAQ:GILD) climbing another 7% in January on the back of treatments like its high-priced hepatitis-C drug Sovaldi. With upward support from those subsectors, health-care stocks could continue to see gains in the future.
It's impossible to tell whether January's stock market trends will last throughout 2014, and for both utilities and more-mature stocks in the health-care sector, trends in the bond market will play a huge role in their overall performance this year. Yet the most important lesson you can learn from these sectors is that even when the market at large is down, you can always find some lucrative opportunity in which you can invest profitably.