Sector ETFs for a Slowing Economic Outlook | ETF Trends

Investors who are looking into ETFs sectors to find ways to position their portfolios should specifically examine defensive sectors.

On the recent webcast, Sector Positioning for an Economic Slowdown, Matthew Bartolini, Head of SPDR Americas Sales Execution and Institutional Strategy, State Street Global Advisors, outlined current market trends, revealing sector investment preferences among investors. For instance, despite weak earnings and heightened uncertainty, Energy led inflows last month, while Health Care, which led on performance from positive earnings, saw outflows.

The Health Care sector has been among the most hated segments this year. Health Care had the most outflows in October despite being the top performer. Additionally, Robert Forsyth III, Head of SPDR Americas Client Enablement Group, State Street Global Advisors, pointed out that flows into Health Care related funds have been negative on a rolling three month basis for seven straight months, hovering near the bottom 10th percentile.

“The only time flows into Health Care were this negative was back during the 2016 Presidential Campaign when Hillary Clinton tweeted about price gouging,” Forsyth said.

Colin Ireland, Head of SPDR Americas Sales Execution and Institutional Strategy, hinted that investors may be missing out on opportunities in the Health Care segment, and broader defensive sectors may still be in play.

“Health Care valuations are constructive and the sector has strong earnings sentiment, while defensive sectors rank high on momentum,” Ireland said.

Bartolini noted that Health Care has the second highest percent of firms with positive Q3 earnings surprises, to go along with the highest surprise magnitude.

On the other hand, Bartolini warned that sectors with high foreign revenue exposures are expected to generate the lowest growth rate in Q3 and in Q4, as the dollars strengthens and trade tensions impaired performance.

Investors, though, may be wary of buying into a market that is trading around all-time highs. Bartolini argued that while the S&P 500 Index is at an all-time high and some may view this as a cause for concern, history indicates subsequent returns have a positive skew.

“Return distributions after an all-time high skews positive, evidence of the momentum effect,” Bartolini added.

Looking ahead, the State Street strategists advised investors to examine defensive sectors through a top-down and bottom-up approach. For instance, in a slowdown period where economic growth starts decelerating but remains positive, the economy is running beyond its full capacity and monetary policy becomes restrictive. The health care, consumer staples and financial sectors have historically generated the highest average return over this cycle while materials, consumer discretionary and real estate were among the worst performers.

Afterwards, the U.S. will be heading toward an eventual recession in the market cycle, with declining economic outputs and aggregate demand, increasing unemployment, low consumer expectations and easing monetary policy. Consumer staples, utilities and health care sectors have exhibited the highest average return over this cycle. In contrast, industrials, technology and real estate have been among the worst performing areas.

“As sector performance varies in each phase of the business cycle, investors may tilt towards sectors which are beneficiaries of the economic environment to position for economic shifts,” Ireland said.

“Equally allocate to Utilities, Staples and Health Care that historically performed well during a recession to help navigate market downturns,” he added.

For example, investors can look to sector-specific ETFs to quickly and easily gain exposure to these market segments, including the Utilities Select Sector SPDR (NYSEArca: XLU), the Consumer Staples Select Sector SPDR ETF (XLP) and SPDR Health Care ETF (XLV).

Additionally, State Street Global Advisors has come out with the actively-managed, sector rotation SPDR ETF, the SPDR SSGA US Sector Rotation ETF (XLSR). The ETF features tactical allocation strategies and are managed by the firm’s Investment Solutions Group (ISG). The SPDR SSGA US Sector Rotation ETF seeks to provide capital appreciation by overweighting or underweighting S&P 500 Sector ETFs based on ISG’s sector return forecasts and research, which includes a proprietary, quantitative sector selection model. It’s a tried-and-true strategy that has allowed State Street Global Advisors to thrive and differentiate themselves in the ETF space.

For XLSR, ISG uses the model results derived and applies qualitative judgment to construct a portfolio of sector ETFs that seeks to maximize returns while meeting risk targets. XLSR gives investors the opportunity to utilize a much-needed sector rotation strategy to their core portfolio.

Financial advisors who are interested in learning more about sector strategies can watch the webcast here on demand.