Energy And High-Yield Stocks Are Market Leaders So Far In 2022

Does US market action in January set the tone for the rest of year? If it does, the investment gods will favor shares in the energy sector and stocks with relatively high dividend yields in 2022, courtesy of strong runs for both slices of the market so far this month, based on a set of ETFs.

“January returns have predictive power for market returns over the next 11 months of the year,” advises a study in the Journal of Financial Economics. A number of other researchers have reported similar results.

Can it be that easy? Buy January’s winners and take the rest of the year off? Even if that’s true, the month has isn’t yet half over and so caveat emptor. Indeed, even something that’s generally true in markets can go horribly wrong for any single time window.

In any case, put your editor down as skeptical that January’s performance is a magic bullet. Then again, there’s no charge for looking.

Let’s start with the broad US equity market: Using SPDR S&P 500 (SPY) as the benchmark, the kick-off to 2022 is wobbly. After an early pop, SPY’s month-to-date performance slumped and is currently under water by 0.8% year to date through yesterday’s close (Jan. 12). On that basis, equities are struggling with headwinds. But slicing and dicing stocks by sectors and risk factors offers a more nuanced view.

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Energy shares are leading US equity sectors by a wide margin so far in 2022. Energy Select Sector SPDR (XLE) is up a sizzling 14.1% year to date. That’s more than double the performance for the second-best sector: financials via Financial Select Sector SPDR (XLF), which is ahead by 6.1% this month.

Energy’s strong start this year is all the more impressive when you consider that it was the top-performing equity sector last year. Note, too, that energy also led the field in January 2021, providing support for advocates of the January effect.

Meanwhile, the worst-performing equity sector so far in January: real estate shares. Real Estate Select Sector SPDR (XLRE) has shed more than 5% so far this month.

Powering the bull run in energy is a hot market for oil and gas prices. “If oil is on the rise and natgas is on the rise, it is going to mean an increase in earnings for those companies that are involved in the energy sector,” says Robert Pavlik, senior portfolio manager at Dakota Wealth Management. Mr. Market seems to agree and is already pricing in expectations for a strong run of earnings reports in the oil patch.

Profiling the US equity market by way of risk factors offers a different perspective. On this front, stocks with relatively high dividend payouts are leading the bulls. Then again, perhaps this is no coincidence given that energy shares tend to offer relatively high payouts. Whatever the driver, Vanguard High Dividend Yield (VYM) is up 2.6% in January, well ahead of the stock market overall and the other major risk factor slices for stocks.

One of the narratives favoring shares with relatively high payouts is the expectation that dividends will offset inflation. That assumes that dividends can grow faster than inflation. By some estimates, that’s a reasonable bet.

Matthew Treskovich, chief investment officer at CPS Investment Advisors, writes: “Over the past sixty years, the growth of dividends has beaten inflation by a wide margin.” Whether that remains true is debatable, but for the moment the market appears inclined to give this view the benefit of the doubt — no trivial matter at a time when inflation has surged and investors are searching for hedging opportunities.

“Dividend stocks are protected against inflation, because firms have been able to raise their prices, their cash flows, and increase their dividends,” advises Wharton School finance professor Jeremy Siegel. “I think that’s what investors are going to seek in 2022.”

By contrast, growth stocks generally are having a rough time so far this month. After running hot in 2021, the growth factor has suffered a reversal of fortunes in January. The deepest cut is in mid-cap growth (IJK), which is in the red by nearly 4%.

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