The top-performing sectors of the US stock market

The end of the Federal Reserve's bond-buying program could signal a return to more normal motivations for investors in the stock market.

"For the last five years, it's been a policy-dominated market," said Russ Koesterich, chief investment officer for BlackRock. "The good news is, we're normalizing now, and we expect the market to be driven more by the business cycle and by fundamentals and less by the Fed."

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Just not yet. While most economists and market analysts believe the U.S. economy is now in midcycle showing consistent moderate growth, the performance of equity sectors in the market continues to buck the historical trend.

Stock market electronic board
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The S&P 500 index was up 9.9 percent this year through Nov. 7. The top two performing sectors of the 10 S&P 500 sectors this year, however, are utilities (up 21.4 percent through Nov. 7) and health care (up 20.7 percent), both defensive sectors of the economy that are supposed to perform better later in the business cycle and in periods of recession. Consumer staples, another defensive sector, has blown away the normally stronger early and midcycle consumer discretionary sector—10.9 percent to 1.7 percent. The three other worst-performing sectors have been energy (–1.4 percent), telecom services (3.6 percent) and materials (4.8 percent).

Most analysts attribute the unusually strong performance of utilities at this stage of the business cycle to investors' search for yield in an environment of ultralow interest rates. While the Fed has ended its quantitative easing program, the yield on the 10-year Treasury bond is a paltry 2.3 percent—down from just over 3 percent at the beginning of the year. With their fat dividends and consistent if uninspiring economic performance, utility stocks have become a popular alternative to fixed-income investments. The strength of health-care stocks and consumer staples is likely a reflection of investors' continuing lack of confidence in the economy.

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"Normally, you want health-care stocks and consumer staples in down markets and consumer discretionary when markets are up," said Jerry Miccolis, manager of the Giralda Fund. He rotates in and out of sector exchange-traded funds based on technical price momentum, not business-cycle indicators. "It's hard to figure."

Which sectors are likely to perform best? The midcycle is typically the longest phase of the business cycle, and the least clear cut in terms of sector-performance leadership. Historically, technology (up 15.3 percent this year), industrials (6.6 percent) and, to a lesser degree, financials (10.3 percent) have done well as corporate capital spending budgets ramp up. Several factors could extend this midcycle phase.

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The first is the relative weakness of consumer spending since the financial crisis. Despite healthy job creation of late, wage growth—the biggest factor in overall inflation—continues to be muted. The second is economic weakness in Europe and Asia. Many analysts expect it to lengthen this period of moderate growth with low inflation in the U.S., possibly favoring cyclically sensitive sectors but not inflation-leveraged sectors, like energy, which tend to perform best late in the cycle.

"People have been concerned that the U.S. is entering the late-cycle phase, but the lack of pricing power in the energy and materials sector is a clear signal that that's not the case," said Lisa Emsbo-Mattingly, director of research in global asset allocation at Fidelity Investments. "Global economic weakness probably means that the U.S. midcycle is extended, and that's bullish for the U.S. market."

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Reading the business cycle accurately may help anticipate how sectors will perform relative to each other, but it won't save you from major market corrections—which usually happen in the midcycle period. With the market roaring back after a 9 percent drop in October, it is up more than 50 percent in the last two years and hasn't had a more than 10 percent correction since the summer of 2011.

Valuations may have more influence in the market now than business-cycle factors, said David Grecsek, director of investment strategy and research at registered investment advisor Aspiriant. "Everything is a little expensive now, and we don't see many opportunities. We'd be happy with a good bunt at this point."