As we consider current macro-economic events and the political environment, exchange traded fund investors can look to specific sector picks to weave in and out of potential market risks and limit the potential negative impact on a diversified portfolio.
In the recent webcast, Why It’s Time for Targeted Sector Positioning, Matthew Bartolini, Head of SPDR Americas Research, State Street Global Advisors; Robert Forsyth III, Head of SPDR Americas Client Enablement Group, State Street Global Advisors; and Colin Ireland, Head of SPDR Americas Sales Execution and Institutional Strategy, State Street Global Advisors, discussed the potential risks we face today and their impact on sectors.
For instance, the strategists warned that given disappointing Q4 results and the threat of the novel coronavirus or COVID-19 pandemic, analysts have downgraded 2020 earnings estimates for Energy, Industrials and Materials by the most. On the other hand, the technology sector has maintained a slightly positive outlook, despite the segment’s high exposure to foreign markets, and utilities were also showed a favorable earnings outlook.
Nevertheless, Bartolini pointed out that the equity markets have suffered through a broad sell-off regardless of the individual sector’s foreign exposures. Companies with high foreign or Chinese market exposures exhibited similar drawdowns to the broad market. Investors, though, should note that the technology sector was the area with the largest international and Chinese revenue exposures, followed by communication services, consumer staples, and health care. On the other hand, utilities, real estate, and financial segments exhibited little to no exposure to foreign revenue.
A Shift To Safety
The coronavirus-induced market fears have also contributed to a shift to safety that pushed bond yields to record lows. Forsyth noted that industries with higher beta exposure to yield suffered the most, notable areas including energy, banks, transportation, insurance, consumer services, healthcare equipment, and materials. On the other hand, industry groups with relatively low sensitivity to 10-year yields have outperformed, including telecommunications, biotechnology, pharmaceuticals, media & entertainment, food beverage & tobacco, household products, semiconductors, and retail.
“Industries with less sensitivity to 10-year yields outperformed, even though some have high foreign revenue exposures,” Forsyth said.
“Industries with high sensitivity to 10-year yields underperformed, even though some have low foreign revenue exposures.”
The recent sell-off may also be a potential buying opportunity for bargain hunters, especially in a potentially oversold energy sector. The energy sector’s price-to-book ratio is at the lowest level ever while its price-to-sales multiple is at the bottom 6th percentile
“Energy’s underperformance relative to the broad market is the worst ever, presenting attractive value opportunities,” Ireland said.
Forsyth also underscored the potential opportunity in the health care segment after political rhetoric weighed on the sector.
“Political headline risks have been driving health care performance, compressing the sector valuations to a level well below historical averages,” Forsyth said.
Potential Volatility
Bartolini outlined the potential volatility that we will continue to experience toward the end of the year as the presidential election draws nearer. The average CBOE Volatility Index, or VIX, the level is historically elevated during the October, November, and December months for an election year, compared to the traditional volatility during the summer August and September months in non-election years.
“Market implied volatility in election years has historically higher in the last quarter, mostly driven by defensive and interest rate sensitive sectors,” Bartolini said.
The markets have exhibited increased sector implied volatility in Q4 relative to yearly averages in the utilities, consumer staples, and health care sectors for an election year compared to non-election years. On the other hand, the energy, materials, consumer discretionary, and industrials segments were among the least volatile during the last quarter of an election year.
State Street Global Advisors offers a suite of widely observed S&P 500 sector ETFs, including:
- Communication Services Select Sector SPDR Fund (NYSEArca: XLC)
- Consumer Discretionary Select Sector SPDR Fund (NYSEArca: XLY)
- Consumer Staples Select Sector SPDR Fund (NYSEArca: XLP)
- Energy Select Sector SPDR Fund (NYSEArca: XLE)
- Financial Select Sector SPDR Fund (NYSEArca: XLF)
- Health Care Select Sector SPDR Fund (NYSEArca: XLV)
- Industrial Select Sector SPDR Fund (NYSEArca: XLI)
- Materials Select Sector SPDR Fund (NYSEArca: XLB)
- Real Estate Select Sector SPDR Fund (NYSEArca: XLRE)
- Technology Select Sector SPDR Fund (NYSEArca: XLK)
- Utilities Select Sector SPDR Fund (NYSEArca: XLU)
Forsyth also argued that investors might consider investing in more focused industry groups as one can tilt toward more favorable industries within a favored sector, enhance/reduce sensitivity to macro variables, target more specific fundamental trends in a sector and increase market cap coverage without stock-specific risk.
For example, the SPDR S&P Insurance ETF (NYSEArca: KIE) can help investors gain targeted exposure to insurance companies, which have historically shown a lower beta to the S&P 500 and a lower beta to the 10-year yield, compared to capital markets, banks, and regional banks. The SPDR S&P Health Care Equipment ETF (NYSEArca: XHE) has been an outperforming area of the broader health care industry. Additionally, the SPDR S&P Internet ETF (NYSEArca: XWEB) continues to show the best 2020 earnings-per-share growth projections for the year ahead.
“Differences among industries in the same sector created dispersions in performance,” Ireland said.
“Industries within the same sector show different risk/return profiles,” he added.
Financial advisors who are interested in learning more about sector strategies can watch the webcast here on demand.