Exchange traded fund investors have piled into defensive stocks ahead of the new year, but market observers warn that the momentum behind these sectors could wane.
Defensive sector ETFs like the Health Care Select Sector SPDR Fund (NYSEArca: XLV) and the Financial Select Sector SPDR Fund (NYSEArca: XLF) reflected some the better performing areas of the S&P 500 over December, rising by 9% or more and outpacing the broader benchmark index’s 5% increase.
Moreover, in December, XLP attracted $697 million in net inflows, and XLV brought in $963 million after bringing in $1.1 billion in November, its best month since July, Reuters reports.
Investors have turned defensive in recent weeks as uncertainty over the new COVID-19 Omicron variant, elevated inflation, and a more hawkish Federal Reserve added to the more cautious market sentiment.
However, some market observers warned that the rally in defensive stocks could be running out of steam and may unwind in early 2022 as investors shift toward big technology and growth stocks again.
Zachary Hill, head of portfolio management at Horizon Investments, argued that some of the strength in defensive stocks may even come from fund managers who are taking profits on outperforming positions and rebalancing positions toward downtrodden areas like defensives, which is a common year-end strategy.
“It’s not terribly surprising after a really good year for stocks to see some of the laggard sectors… do a little bit better,” Hill told Reuters. “That’s something that could potentially reverse in January.”
Rob Haworth, senior investment strategist at U.S. Bank Wealth Management, also pointed out that higher Treasury yields could also weigh on defensive stocks, especially with a more hawkish Fed eyeing higher rates. The Fed signaled a faster tapering of its post-pandemic asset purchasing programs and potentially three rate hikes this year.
All in all, investors should still brace for more volatility in 2022. Hill warned that stocks are likely to be more volatile after a relatively placid 2021. The S&P 500’s one-month volatility averaged 12.5 for 2021, the lowest since 2017, according to Refinitiv data.
“It won’t be nearly as straight a line as we had this year but we still think the outlook for stocks is broadly positive,” Hill added.
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