Since Jan. 30, 10-year Treasury yields have climbed 18.6% and while it is not guaranteed the Federal Reserve will raise interest rates this year, that recent rise in government bond yields stoked renewed interest in cyclical sectors and the corresponding exchange traded funds.
The technology, industrial and materials companies are among cyclical sectors that typically strengthen in a rising rate environment as investors turn away from safer assets and shift into riskier areas of the market.
Focusing on materials, the third-smallest sector weight in the S&P 500 was a laggard last year as the Materials Select Sector SPDR (NYSEArca: XLB) returned just 7.2%, or barely more than half what the S&P 500 delivered. The combination of a strong dollar and slack oil prices pressure materials stocks and ETFs.
In theory, materials stocks should be winner in a low energy price environment because lower oil and gas prices reduce input costs for energy-intensive materials producers and chemicals manufacturers. In reality, that was not the case last year. [Materials ETFs hit by Falling Oil Prices]
The trend has reversed in 2015 with XLB soaring 5%, good for the best performance among the nine sector SPDR ETFs. On Thursday, XLB and the Guggenheim S&P Equal Weight Materials ETF (NYSEArca: RTM), 2014’s top materials ETF, were two of just over 100 ETFs to hit all-time highs. [2014’s Best Materials ETF]
Investor sentiment toward the materials sector is just starting to improve, indicating the sector’s rally could have room to run.
“According to SentimenTrader’s proprietary models, sentiment on the materials sector, specifically on the popular SPDR Material ETF, XLB, is only just emerging from an extreme bearish condition. Similar extreme bearish levels have led to bottoms in the XLB and powerful rallies. This suggests, perhaps, that there is plenty of room aboard the materials bandwagon before it gets ‘overbought’ or ‘overcrowded,,” notes Dana Lyons of J. Lyons Fund Management.
While equal-weight ETFs have been more than legitimized over the years, some critics allege that the advantages of these products are solely tied to deeper exposure to small-caps and/or value stocks. However, it is Guggenheim’s ability to efficiently rebalance ETFs such as RSP and RTM that tells the true story. Plus, RTM is not heavily tilted toward smaller stocks, nor is the materials sector notably inexpensive compared to the S&P 500.
In the past month, RTM and XLB are up 7.1% and 5.6%, respectively. However, devoted seasonal traders are unlikely to be surprised by the materials sector recent strength. Dating back to 1999, the first full year of trading for the nine sector SPDRs, XLB is historically the second-best performer in February, trailing only the Energy Select Sector SPDR (NYSEArca: XLE). [February’s Best Sector ETFs]
For now, it appears investors need some cajoling to get involved with materials ETFs. RTM has added $4.4 million in new assets this year, but XLB and the Vanguard Materials ETF (NYSEArca: VAW) have lost a combined $40 million.
With bearish sentiment just starting to ebb and the charts for RTM and XLB showing legitimate breakouts, investors may not wait too much longer to embrace the materials sector.
Guggenheim S&P Equal Weight Materials ETF
