If the Federal Reserve moves toward interest rate normalization in December, some market segments and sector exchange traded funds could underperform during the rising rate environment.
Erin Gibbs of S&P Investment Advisory Services is singling out the industrial and materials sector since both higher rates and a stronger dollar would put pressure on these two market segments, reports Stephanie Yang for CNBC.
For ETF investors, that could spell trouble for industrial sector-specific funds, including the Industrial Select Sector SPDR (NYSEArca: XLI), Vanguard Industrials ETF (NYSEArca: VIS), iShares U.S. Industrials ETF (NYSEArca: IYJ) and Fidelity MSCI Industrials Index ETF (NYSEArca: FIDU).
Gibbs, though, believes that the materials sector could stand to suffer the most. Investors may want to keep an eye on the Materials Select Sector SPDR (NYSEArca: XLB), Vanguard Materials ETF (NYSEArca: VAW) and iShares U.S. Basic Materials ETF (NYSEArca: IYM).
“Obviously these are both heavily tied to the dollar story,” Gibbs told CNBC. “But I think the most vulnerable fundamentally is really the materials sector.”
The materials sector has been suffering under a stronger dollar, which has diminished foreign revenue streams and weighed on commodity prices.
Gibbs projects that earnings for the materials sector will contract 5% over the next 12 months. Moreover, the sector is trading at relatively rich valuations compared to others at 7.5 times projected earnings.
Boris Schlossberg of BK Asset Management also pointed to potential weakness in oil exploration ahead. After the SPDR S&P Oil & Gas Exploration & Production ETF (NYSEArca: XOP) rallied over 16% this quarter, Schlossberg warned investors to stay away.
“They’re going to get squeezed both from the fact that oil stays low … and that rates go up and they’re all very overleveraged,” Schlossberg said, referring to the debt on those companies’ balance sheets. “Any rally in XOP is pretty much an opportunity to sell.”
More aggressive traders may jump on the negative oil exploration outlook with the recently launched Direxion Daily S&P Oil & Gas Exploration & Production Bear Shares (NYSEArca: DRIP), which takes the -3x, or -300%, daily performance of the S&P Oil & Gas Exploration & Production Select Industry Index.
For more information on the market sectors, visit our sector ETFs category.
Max Chen contributed to this article.