Investors can capitalize on a shifting market and changing business cycles through sector-specific exchange traded fund plays.
On the recent webcast, Strategizing with Sectors, Jared Rowley, Research Strategist for State Street Global Advisors, pointed out that different sectors show varying correlations to the benchmark S&P 500 index. [Sector ETFs to Capture Cyclical Trends]
For instance, the Industrial Select Sector SPDR (NYSEArca: XLI) shows a 0.92 correlation to the S&P 500 index – a 1.0 reading reflects perfect correlation or two securities with mirror performances. On the other hand, the Utilities Select Sector SPDR (NYSEArca: XLU) shows a 0.61 reading, the lowest correlation to the S&P 500.
Advisors may find that some sectors typically exhibit a higher correlation to the broader S&P 500, which suggests that industrials, consumer discretionary and technology sectors are better plays during a broad market rally. In contrast, sectors with lower correlations, such as health care, consumer staples and utilities, would provide a more conservative or defensive play.
Additionally, David Mazza, Head of Research of SPDR ETFs and SSgA Funds, mentioned that various sectors may also exhibit a predominant style. For instance, the Utilities Select Sector SPDR and the Consumer Staples Select Sector SPDR (NYSEArca: XLP) both show predominantly value styles, whereas the he Technology Select Sector SPDR (NYSEArca: XLK) and Consumer Discretionary Select Sector SPDR (NYSEArca: XLY) show greater growth styles.
Due to cyclical market trends, various sectors can underpeform or outperform in a rotating business cycle. For example, Rowley identified that the Information Technology Select Sector Index was the worst performing sector in 2002 after a 39% plunge, but the sector was the best performer in 2003 after a 38% surge. In contrast, the Utilities Select Sector Index was the best performer last year after a 24% jump, but it is lagging other sectors this year after a 7% decline.
Since various sectors may offer varying risk profiles during different business cycles, advisors can also equally weight sector ETFs to minimize losses in a bear market, according to Randy Swan, President and Portfolio Manager for Swan Global Investments.
“Equal weighting can be a simple and effective contrarian strategy,” Rowley said.
Specifically, an equal-weight S&P 500 sector strategy would underweight technology, financials, health care and consumer discretionary while overweighting industrials, consumer staples, energy, materials and utilities.
Moreover, Mazza noted that advisors can take a tactical view with industries or sub-sectors to complement parent sectors. For instance, Mazza mentioned top industry ideas that State Street Global Advisors like right now, including the SPDR S&P Health Care Services ETF (NYSEArca: XHS), SPDR S&P Regional Banking ETF (NYSEArca: KRE), SPDR S&P Transportation ETF (NYSEArca: XTN) and SPDR S&P Biotech ETF (NYSEArca: XBI), as these sectors show relatively low sensitivity to a strong U.S. dollar, rising interest rates environment and crude oil prices.
Financial advisors who are interested in learning more about sector ETFs can listen to the webcast here on demand.
For more information on market sectors, visit our sector ETFs category.