Blog - Investing Notes

June 6, 2008 - Do Any Sector ETFs Reliably Lead or Lag the Market?

Do any of the major stock market sectors systematically lead or lag the overall market, perhaps because of some underlying economic cycle? To investigate, we examine the behaviors of the nine sectors defined by the Select Sector Standard & Poor's Depository Receipts (SPDR), all of which have trading data back to December 1998:

Materials Select Sector SPDR (XLB)
Energy Select Sector SPDR (XLE)
Financial Select Sector SPDR (XLF)
Industrial Select Sector SPDR (XLI)
Technology Select Sector SPDR (XLK)
Consumer Staples Select Sector SPDR (XLP)
Utilities Select Sector SPDR (XLU)
Health Care Select Sector SPDR (XLV)
Consumer Discretionary Select SPDR (XLY)

Using monthly adjusted closing prices for these exchange traded funds (ETF) and for the S&P 500 index mimicking SPY (to represent the overall stock market) over the period 1/99-5/08 (113 months), we find that:

The following chart shows the correlations of coincident monthly returns for each of the nine sector ETFs with the monthly returns of SPY over the period 1/99-5/08, displayed in order of decreasing correlation. Consumer staples, utilities and energy have the lowest coincident correlations and are therefore the best candidates for market leaders or laggers.

To test for lead-lag relationships, we calculate correlations for the monthly returns of each ETF offset by -12 months (sectors lag the market) to +12 months (sectors lead the market) with respect to the monthly returns of SPY. If there is a systematic leading or lagging relationship between a sector ETF and SPY of a year or less, it should emerge as a notably positive or negative correlation over this range of offsets.

The following chart shows the offset correlations for the consumer staples, utilities and energy sector ETFs. The coincident correlations are clearly the strongest, but there is evidence that utilities have some tendency to lag market trends by a month. Correlations for other sector-market lead-lag relationships appear to be noise.

The next chart shows the offset correlations for the materials, financial and health care sector ETFs. The coincident correlations dominate, and correlations for other sector-market lead-lag relationships appear to be noise.

The final chart shows the offset correlations for the consumer discretionary, industrial and technology sector ETFs. The coincident correlations again dominate, and correlations for other sector-market lead-lag relationships appear to be noise.

Note that offsetting monthly returns modestly reduces sample size. Note also that the sample is very small in term of number of underlying economic cycles.

In summary, there is little evidence that sector ETFs systematically lead or lag the overall market over the past decade.

For related research, see Blog Synthesis: The Economy and the Stock Market.