Industries change. Companies change. Valuations change. It should come as no surprise, then, that sector behavior in the stock market can change as well.

Let’s take a look back at the ten S&P 500 sectors since data became available in October 1989.

Defensive vs. Cyclical

We generally break down the sectors into two main categories based on annualized volatility (see chart below):

Defensive sectors: Utilities, Consumer Staples, and Health Care

Cyclical sectors: Telecom, Energy, Industrials, Consumer Discretionary, Materials, Financials, and Technology

Changing Technology

However, this chart doesn’t tell the whole story. Technology has been the most volatile sector on average since 1989 but that volatility has been far from constant. Is Tech the same sector today as it was back in 2000?

As it turns out, it not even close to the same. The top five weightings in the Technology sector today (comprising 40% of the index) are Apple, Microsoft, Intel, Google, and IBM. All of these are well-established companies with real earnings and valuations more closely in line with the broad market, a much different picture than what persisted in the late 1990’s and 2000.

According to Patrick O’Shaughnessy of O’Shaughnessy Asset Management, the percentage of “cheap” companies that are in the Tech sector is higher today than almost any other period in history (see yellow in chart below)

Source: Millenial Invest

As a result of this and the increasing perception of safety given its high cash levels, Tech now has the lowest volatility of any of the cyclical sectors. In the chart below, you’ll notice technology volatility (green line) started deviating from the rest of the cyclical sectors in the late 1990’s as the “dot-com bubble” took hold.

As the bubble burst, volatility slowly moved back in line with the other cyclical sectors and in recent years it has taken a more defensive tone. In fact, over the past 24 months it actually has the lowest volatility of any sector, even lower than the three defensive sectors.

Changing Financials

Another notable sector with a significant change in behavior has been Financials. After exhibiting low volatility from 2002-2006, its volatility began moving sharply higher in 2007. During the financial crisis and its aftermath, it was by far the most volatile sector (see red line in chart below).

Today, like Technology, Financials are behaving in a more defensive fashion. Leverage and risk in the sector has declined and the perception today is that these are more stable companies with stronger balance sheets.

Changes to Come

What sectors today should we keep an eye on for a potential shift in behavior?

Energy is an obvious choice based on the sharp decline in Crude in recent months and indeed it has been by far the most volatile sector this year.

I would also watch the Health Care sector more closely here. Its beta has been steadily rising over the past two years as the higher volatility Biotechnology stocks have become a more important driver of returns.

Concluding Thoughts

Sectors change over time and their behavior in the stock market changes as well. Monitoring these changes are important for investors as sector volatility is a key driver of overall volatility in most equity portfolios. It can also be important from a signaling standpoint, as heightened volatility in Technology and Financials were precursors to significant declines in these sectors and eventually the broad market as well.

This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.

CHARLIE BILELLO, CMT

Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.

You can follow Charlie on twitter here.