The U.S. economy is looking better than previously expected, and investors who are looking to increase their exposure to the domestic market should target financial and healthcare sectors, along with related exchange traded funds.
“You can have kind of a slow recovery, a slow retrenchment from the Fed, slow reflation and that could be a pretty positive backdrop for equities,” Adam Parker, Morgan Stanley’s chief U.S. equity strategist, said on CNBC.
Notably, Parker argues that financial stocks have upside potential, and both Morgan Stanley’s research and client surveys show optimism over the sector. Additionally, Parker believes banks are also set to benefit from a Federal Reserve interest rate hike ahead. [Look to Bank ETFs in a Rising Rate Environment]
“I think you could see much more of that over the next six to nine months, so we really like the financials. I think it has defensive attributes because of share repurchases and dividend growth because of CCAR,” Parker said, referring to the Fed’s process for reviewing capital reserves. “It doesn’t really get affected by currency. And then you have this offensive attribute of an economically sensitive business that’s not really fully embedding that from the valuation perspective.”
Investors interested in the financial sector can take a look at broad options like the Financial Select Sector SPDR (NYSEArca: XLF), iShares U.S. Financials ETF (NYSEArca: IYF) and Vanguard Financials ETF (NYSEArca: VFH). Banks make up 37.2% of XLF, 32.2% of IYF and 40.8% of VFH.
Alternatively, investors can focus on bank stocks through SPDR S&P Regional Banking ETF (NYSEArca: KRE), iShares U.S. Regional Banks ETF (NYSEArca: IAT), PowerShares KBW Bank Portfolio (NYSEArca: KBWB) and SPDR S&P Bank ETF (NYSEArca: KBE). [Bank ETFs Offer Attractive Value]
Additionally, Morgan Stanley is above neutral on healthcare stocks. However, Parker warns that there may be some selling pressure in the space after the outperforming run in the healthcare sector.
Year-to-date, the Health Care Select Sector SPDR (NYSEArca: XLV) gained 12.5%, iShares U.S. Healthcare ETF (NYSEArca: IYH) rose 13.4%, Vanguard Health Care ETF (NYSEArca: VHT) increased 14.3% and Fidelity MSCI Health Care Index ETF (NYSEArca: FHLC) advanced 13.3%.
“I’m a little bit worried that you’ll see some of the biotechs and roll-up names get sold as the rates rise. Biotech in particular has a lot more sensitivity to interest rates than maybe everyone realizes,” Parker added.
Biotech makes up a good chunk of the healthcare sector. For instance, biotechs account for 21.1% of XLV’s holdings. Moreover, the sub-sector has been among the best performing areas of the market, with the iShares Nasdaq Biotechnology ETF (NasdaqGS: IBB) up 26.3% and the SPDR S&P Biotech ETF (NYSEArca: XBI) 39.5% higher year-to-date. [Two Big Biotech ETFs]
For more information on the markets, visit our sector ETFs category.
Max Chen contributed to this article.