July 2020 Newsletter

Investors are bombarded with news about how well (and poorly) individual companies perform and how well groups of companies that share similar business characteristics might perform given certain economic environments.

Unfortunately, many use the terms “sector” and “industry” incorrectly and it’s important to understand the differences between the two, because what many refer to as “an industry” is actually “a sector.” While it might sound like splitting hairs, it’s not, as financial advisors are more apt to focus on sectors as an additional diversification tool.

Creating Categorizations of Companies

The global economies and by extension each of the stock markets within and all publicly traded companies, are essentially organized into hierarchical levels:

• At the highest level we find 11 groups of similar companies called sectors;
• Below the 11 sectors we find 24 industry groups;
• Below the 24 industry groups we find 69 industries; and
• Below the 69 industries, we find 158 sub-industries.

As we move down the hierarchical pyramid, the characteristics of the companies within the groupings become tighter. In other words, two companies categorized within the same sub-industry share more economic characteristics versus two companies categorized in the same sector.

Sectors Can Help Diversification

Financial advisors examine historical sector performance and analyze how companies are organized into different industries because both are important tools when building diversified portfolios for clients.

The reason is that because over every single time period, sector performance is driven largely by factors one would expect, such as the overall state of the economy, underlying corporate earnings, current and predicted interest rates, and inflation, among other factors. And financial advisors know that reviewing sector performance on a monthly, quarterly, semi-annually and yearly basis proves one thing:

• Sectors do not move in lock-step with one another and will often provide very divergent returns for investors – depending on timing and the current economic climate

The S&P 500

The S&P 500, sometimes simply called the S&P, is a stock market index that represents the collective performance of 500 publicly traded, large-cap companies in the U.S. (ok, technically there are 505, but let’s talk about that another time). Representing about 80% of the U.S. equity market, the S&P 500 is one of the most often-cited proxies for the U.S. stock market.
Introduced in 1957, the S&P 500 is maintained by S&P Global and in order for a company to be included in the S&P 500, it must meet certain criteria, including:

• Be in the U.S. with an unadjusted market cap of at least $8.2 billion
• At least 50% of its stock must be available to the public
• It must file a 10-K annual report
• Have at least four consecutive quarters of positive earnings
• Be listed on the New York Stock Exchange, NASDAQ, Investors Exchange or BATS Global Markets

The 11 S&P 500 Sectors

Each of the companies within the S&P 500 is categorized into one of 11 sectors and for most of them, the name of the sector says it all:

Information Technology sector contains companies that develop or distribute technological items or services.

Health Care sector contains companies that develop or distribute medical supplies and pharmaceuticals.

Financials sector contains companies involved in finance and investing.

Consumer Discretionary sector contains companies that develop or distribute products that are considered luxury items (not needed to survive).

Communication Services sector contains companies that allow us to communicate – internet and phone providers, media, and entertainment companies.

Industrials sector contains a broad swath of companies, including airlines, construction and railroad companies.

Consumer Staples sector contains companies that are needed to live (the opposite of consumer discretionary). Think food and beverage companies.

Energy sector contains companies that are in the oil and gas business in some way.

Utilities sector contains companies that provide electricity, water and natural gas to consumers and businesses.

Real Estate sector contains Real Estate Investment Trusts, realtors, home-builders and similar companies.

Materials sector contains companies that provide raw materials, like copper, zinc and paper.

The Percentage of Each Within the S&P

The percentages of each sector within the S&P 500 as of the end of June is as follows:

• Information Technology: 24.4%
• Health Care: 14%
• Financials: 12.2%
• Communication Services: 10.7%
• Consumer Discretionary: 9.9%
• Industrials: 8.9%
• Consumer Staples: 7.2%
• Energy: 3.6%
• Utilities: 3.5%
• Real Estate: 3.1%
• Materials: 2.5%

Why Sectors Matter

As evidenced in the first six months of 2020, the relative performance of each sector tends to rotate as the overall economy shifts from one business cycle to the next. But this is not a phenomenon that is new – sectors have always rotated from performance leaders to performance laggards based on structural shifts in the economy.

For example, some sectors are considered more sensitive to interest rate movements – financials, real estate and consumer discretionary.

Other sectors are considered more economically sensitive, meaning they do better when moving from recession to recovery – industrials and information technology for example.

Some sectors are considered more defensive, like utilities and health care.

Sector Performance in 2020

The overall trend for sector performance in 2020 has been mixed, as performance leaders and laggards have rotated all year.

You might remember, for example, that in the first quarter of 2020, all 11 S&P 500 sectors were negative, whereas April saw all of them positive, the month of May saw most of them positive and June saw less than half of them positive.

Reviewing the sector returns for the second quarter and YTD through June 30, 2020, we saw that:

• Every single one of the 11 S&P 500 sectors was positive for the second quarter of 2020
• The Utilities sector was the worst performer for the second quarter as it barely crept into positive territory
• The differences between the best performing and worst performing sectors in Q2 were dramatic, with three sectors (Consumer Discretionary, Information Technology and Energy) up more than 25x the Utilities sector
• On a YTD basis, the differences between the best and worst performing sectors is just as dramatic, with a difference of over 50% as Information Technology sector is up over 14%YTD and Energy is down a whopping 37%

Here are the sector returns for shorter time periods through the end of June 30, 2020:

Knowing which sectors have historically performed well during certain market environments is just as important as knowing which ones have performed poorly in certain environments.

Your financial advisor can help you better understand how and when to use sectors within your overall asset allocation.

^{Source: Copyright © 2020 Financial Media Exchange. All rights reserved.} 

When I decided to purchase long-term care insurance in my early 50s, I thought I was being so responsible. But 14 years later, facing my second premium increase, I began to wonder whether it was the right decision.

The COVID-19 pandemic and its lopsided impact on the elderly, particularly those living in communal settings such as assisted living facilities and nursing homes, has focused renewed attention on long-term care. But finding insurance to cover the potentially devastating costs of an extended stay in a care facility — or the ability to receive care at home as an alternative — has become increasing difficult and costly.

Many financial advisers and consumers have moved away from traditional LTC insurance over the past two decades in favor of hybrid products as the result of large premium hikes on in-force LTC policies that insurers had originally underpriced. A combination of low interest rates, increasing longevity, lower-than-expected lapse rates and a spike in health care costs contributed to insurance companies’ need to repeatedly increase LTC premiums.

However, understanding the reasons behind the price hike doesn’t make it any easier to swallow. My husband and I were notified recently that the monthly premium for our John Hancock long-term care insurance will increase by 35% beginning in mid-October if we want to keep our existing policies. Or we could scale back some of our current benefits to maintain our premiums at today’s prices. This increase follows a 23% premium hike in 2012.

Our long-term care policies cover each of us for up to four years after a 90-day elimination period. Our shared benefit option would allow one of us to borrow from the other spouse’s benefit pool if necessary. With 5% compound inflation, our initial $200-per-day benefit has nearly doubled, to $397 — about the cost of care for a private room in a nursing home today.

Together, we have paid more than $60,000 in combined long-term care insurance premiums over the past 14 years, giving us each more than $500,000 in potential long-term care coverage. Given our current ages of 65 and 68, we could be paying those premiums for another decade or two before we might need to access those benefits. But without insurance, that same $60,000 would pay for just six months of nursing home costs today.

I was curious about what might have happened if we had waited to buy long-term care insurance — assuming we could qualify for coverage. And that’s a big if. Insurers have been getting pickier about who qualifies for a stand-alone long-term care policy in recent years. In 2019, one-third of applicants in our current 65- to 69-year-old range were denied coverage, according to the American Association for Long-Term Care Insurance.

I asked AALTCI executive director Jesse Slome to crunch some numbers for me to estimate how much a similar policy would cost us today — if we were healthy enough to qualify.

Together, my husband and I pay less than $400 a month for our current coverage; those premiums are scheduled to rise to about $530 a month combined if we stick with our current benefits. John Hancock stopped selling stand-alone LTC policies in 2017 in favor of life insurance policies with LTC riders, but it continues to service existing policies.

To buy similar policies from another insurer would cost us more than $2,300 per month — nearly six times as much as we currently pay. That cost comparison made me feel a bit better about buying long-term care insurance when we were younger. But I still wondered whether we should accept the premium hike or pare back some of our coverage to trim expenses.

“Periodically, it is smart to reevaluate and rebalance your present financial status and your expectations from your long-term care insurance,” Slome told me. “A rate increase often prompts that circumstance, just like a stock market correction.”

“It seldom makes sense to walk away from a long-term care policy after years of paying premiums,” he said. “Don’t drop it. Edit it.”
John Hancock did a good job of laying out our options to prevent a premium increase, including scaling back on inflation protection, reducing the daily benefit or agreeing to share 16% of the costs with the insurer. Although our current 5% compound inflation option has done a great job of keeping up with current costs, I’m leaning toward reducing our inflation protection to 3.2% — about standard for today’s policies — to maintain our current premium because we have already been warned that another premium hike is coming.

“We are currently expecting to request an average increase of approximately 30% across all of our policy series,” John Hancock said in a letter accompanying the notice of the current increase. “No additional rate increase will be effective earlier than 12 months from the effective date of the current rate increase.” That gives me a year to contemplate my next move.

^{Source: Franklin, M. (July 16, 2020). https://www.investmentnews.com/responding-long-term-care-premium-hike-195111}