Macro-Driven Investing in Sector ETFs

Note: This article appears on the Strategist Channel

By Jan Erik Wärneryd

In a previous article [An Introduction to Investing in Sector ETFs] I discussed the importance of considering the long-term relative growth of various industries when evaluating sector ETFs. In this article I will share a bit about how we at Hillswick incorporate shorter-term macro-economic factors into our strategy.

Many equity portfolio managers like to tell investors they focus solely on stock-picking; finding the best companies according to whatever criteria they focus on while disregarding the broader economy. The idea is that this narrow focus at the company level is where the added value lies, since forecasting the economy is difficult and not even economists seem to be very good at it!

At Hillswick, we see this as an opportunity.  Since it is likely the market in specific stocks is fairly efficient given all the focus and effort devoted to analyzing them, we seek to add value by incorporating macro-economic views in our sector rotation strategy. Using sector ETFs takes the focus away from individual stocks and allows us to look at the “big picture” and to incorporate both long-term factors such as share of GDP and shorter-term ones such as FED policy and currency moves.

My own background is in Global Macro trading and portfolio management, where strategies are adopted based on expected changes in economic conditions in whatever markets and countries represent opportunities. This perspective comes in handy even when working within the more limited opportunity set of the S&P 500 Index since most large corporations are exposed to global factors.

Macro factors

Among the most obvious global Macro factors to look at are global growth prospects, currency moves, political events and changes in commodity prices. These are all exogenous, or externally driven, factors that have the power to impact the U.S. economy and in particular corporations with international operations and/or significant trade exposure.

Currency moves, for example, impact prices received and paid for exports and imports (transaction exposure) and the relative competitiveness of one country versus another. They also impact the value of a company’s assets abroad (translation exposure). If the U.S. Dollar increases in value versus other currencies, U.S. based exporters receive fewer Dollars when exchanging their foreign currency income whereas importers to the U.S. benefit from lower prices. Since U.S. corporations have significant holdings of foreign assets, there is a negative balance sheet effect when translating the value of these holdings back to U.S. Dollars if the Dollar strengthens.