Cyclical sector exchange traded funds were, for the most part, laggards in 2014. For example, the Industrial Select Sector SPDR (NYSEArca: XLI) and the Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) posted an average of 2014 return of about 10%.
Investors that stuck with more boring, less volatile sectors did far better as the Consumer Staples Select Sector SPDR (NYSEArca: XLP) gained 15.7% while the Utilities Select Sector SPDR (NYSEArca: XLU) thrived on the back of plummeting 10-year Treasury yields to surge almost 29%.
However, now that the bull market is aging, late-cycle sectors and the corresponding ETFs could be in play this year.
“Differentiation between sectors will also drive returns at this point in the cycle, especially when important economic and market themes come into play. For example, the rout in oil prices in the second half of 2014 primarily affected the energy sector but over the next several quarters, lower energy prices should benefit consumer sectors,” said J.P. Morgan Asset Management in a note out earlier this year.
Among cyclical sectors that look attractively valued, according to J.P. Morgan Asset Management, is technology. The Technology Select Sector SPDR (NYSEArca: XLK) is an example of a cyclical ETF that did outperform last year with a gain of 18%. Still, investors were leery of embracing big tech names and pulled over $1.5 billion in 2014. [Finally Some Love for a Big Tech ETF]
“Dispersion between sector valuations should continue to grow. For example, technology stocks appear attractive based on both forward and trailing P/E ratios when compared with their long-run histories. In contrast, the utilities sector, which many have used as a bond substitute, looks expensive on both measures,” said J.P. Morgan in the note.
After the recent surge in the utilities space, XLU is now showing a price-to-earnings ratio of 18.8 and a price-to-book of 1.8, according to Morningstar data. In comparison, the S&P 500 index has a 18.0 P/E and a 2.5 P/B. [Utilities ETFs Look Pricey]
With any market observers are expecting the Federal Reserve to raise interest rates this year, dividend growth stocks and ETFs could offer an advantage.
“Dividend yields have been an important driver of sector returns as investors have searched for yield, but dividends will become less important as interest rates slowly normalize. Investors will be well-advised to select sectors with a positive correlation to Treasury yields, and avoid sectors that investors have piled into looking for income,” notes J.P. Morgan.
The consumer discretionary sector has a 0.06 correlation to Treasury yields compared to -0.5 for utilities, according to J.P. Morgan data. Additionally, discretionary is expected to be one of just two sectors to show double-digit dividend growth this year. Financial services is the other. [The Growth of Dividend ETFs]
Consumer Discretionary Select Sector SPDR