Investors had to deal with market volatility during the summer months, as a long-awaited correction in major market benchmarks finally happened on concerns about a slowdown in the global economy. As those who invest in sector-specific exchange-traded funds can attest, the impact of the market's decline hit some portions of the stock market harder than others, and in particular, three much-followed sector ETFs suffered double-digit percentage declines during the third quarter. As tough as that was for shareholders, value-oriented investors now wonder if these beaten-down areas of the market are likely to rebound. Let's take a closer look at which sectors took the most damage and how their prospects are for the rest of 2015.
Commodities led the way down
Two SPDR Select ETFs had almost identical performance, and both endured losses because of poor performance in the commodity sector. The Energy Select Sector SPDR ETF (NYSEMKT:XLE) was the worst performer on the quarter, falling almost 18% between June and September. The Materials Select Sector SPDR ETF (NYSEMKT:XLB) fared almost as badly, with a decline of 17% for the third quarter.
It's no secret why energy did so badly during the quarter. Prices of crude oil resumed their drop from earlier in the year, and producers suffered from conditions that brought about the lowest gasoline prices in the U.S. since 2004. Natural gas prices also fell sharply, falling from close to the $3 level to about $2.50 over the course of the quarter. These downward moves put even greater pressure on energy stocks, adding to the declines that have sent the energy ETF down 30% over the past year.
For materials, a host of factors came into play. Prices for base metals like copper also fell dramatically during the quarter, and that hurt a number of companies in the mining industry, both among those that specialize in copper production and those that focus primarily on other metals but nevertheless reduce their cash costs through selling the copper byproduct from their production processes. Chemical company stocks sank as an indirect result of weak crop prices, as many of the major companies in the industry have moved to emphasize agricultural products like fertilizers and seeds to drive growth in past years.
The other poor performer during the third quarter was healthcare, with the Healthcare Select Sector SPDR ETF (NYSEMKT:XLV) dropping 11%. The sector took a big hit from the biotechnology arena, where previously soaring share prices gave way to a vicious reversal that pulled down even the biggest players in the space by double-digit percentages.
Some healthcare analysts are worried that the recent attention that high prices for drugs and other treatment options could lead to a backlash of regulation or other adverse moves that could affect profitability. With drug and biotech companies building the costs of research, clinical trials, and other overhead costs into the prices of their approved treatments, any attempt to rein in those prices will eat into profit margins. At the same time, major companies in the sector are also dealing with the inevitability of losing patent protection on their biggest blockbuster sellers, further heightening the importance of squeezing as much profit as possible before generic competition wipes out most of the opportunity to earn revenue.
Will these sectors rebound?
Already in the fourth quarter, we've seen a huge rebound in two of these sector ETFs. The Energy ETF has soared 12%, while the Materials ETF is up 10%. The Healthcare ETF has also risen but by a more modest 3% or so.
Given the massive losses that energy and materials have seen over the past year, the share prices for their ETFs were ready to bounce on even the hope of a recovery. With oil prices climbing back above $50 per barrel and with base metals and other commodities starting to follow suit, the question will be whether new supply and-demand relationships will support a long-term uptrend. If so, then the Energy and Materials ETFs could recover nicely. For healthcare, on the other hand, uncertainty could well last a while as regulators slowly ponder their options and investors have to wait to see what if any effect they'll have on profits.