ETF investors may look to tactical strategies as a way to construct sector-based investment ideas for the current market environment.
In the recent webcast, 3 Tactical Strategies for Sector-Based Investing, 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 Institutional & Home Office Strategy, State Street Global Advisors, looked at the current market environment and outlined some strategies that investors could take to capture opportunities ahead.
Recent sector flows and trends reveal a shift away from healthcare, along with greater interest for the real estate, technology and financial sectors. Real estate has been a notable standout as it led flow momentum over the past three months.
Looking at the recent earnings updates, health care and real estate earnings projections showed stronger results during the recent wave of downgrades, with more upgrades than downgrades compared to their peers. On the other hand, the energy, materials and consumer discretionary sectors revealed the least positive sentiment or lowest upgrade to downgrade ratio.
As investors look to their strategic allocations, the strategists outlined three sector construction approaches to the market today. For starters, investors can take a bottom-up approach with valuations in mind. The technology and consumer discretionary sectors exhibit high price-to-book and price-to-earnings, compared to their 15-year average. On the other hand, financials, energy and materials are all among the cheapest areas of the market.
A momentum strategy that seeks to capture the strongest performance trends among sectors could be another bottom-up approach. The communication services, real estate and utilities sectors currently exhibit some of the strongest forward momentum, whereas energy, health care and industrials have shown low momentum in the current market.
Looking at the top-down approach, the strategists argued that investors could overweight sectors with negative sensitivity to yields in a falling yield environment. For example, real estate -0.19 correlation, utilities has a -0.16 correlation and consumer staples shows a -0.07 correlation to the U.S. 10-year yield. On the other hand, oil & gas equipment & services has a 0.64 correlation, regional banks has a 0.54 correlation and banks show a 0.51 correlation to the 10-year yield.
While some may argue that the financial sector faces challenge in a low rate environment, there are still some opportunities. For example, regional banks, Wall Street banks and insurance companies exhibit a high beta sensitivity to the S&P 500 as the economy expands. The strategists pointed to something like the SPDR S&P Insurance ETF (NYSEArca: KIE) as a way to focus on a potentially opportunity within the broader financial sector.
With heightened concern over trade tensions, investors may also look toward sectors with less foreign exposure or focus on domestically oriented areas. Technology segments like semiconductors, electronic equipment and hardware have a high percentage of foreign revenue exposure. On the other hand, software and services have some of the lowest foreign exposure within the broader tech space. Investors could look to something like the SPDR S&P Software & Services ETF (NYSEArca: XSW) as a targeted play on the technology sector.
The strategists also highlighted the increased merger and acquisition activity as a potential investment opportunity. As a result of its weighting methodology that leans more toward smaller companies, the SPDR S&P Biotech ETF (NYSEArca: XBI) has enjoyed a bump from being overweight M&A targets in most of the top deals from January 2015 through 2019.
Another theme that has stood out this year was the growth in solar energy. Strong overseas demand due to the affordability of solar panels and accelerated development of domestic solar installments before the eventual phasing out of federal tax credits helped support the outperformance in the sector. Investors could also tap into this growth with something like the SPDR S&P Kensho Clean Power ETF (NYSEArca: CNRG), which has also been one of State Street Global Advisor’s best performing sector-specific ETF plays of the year.
As a way to incorporate these ideas into a diversified portfolio, the strategists argued that investors could carve out a quarter of the U.S. equity exposure to allocate to the top three sectors based on fundamentals, macro trends and/or technical analysis.
Financial advisors who are interested in learning more about strategies for the current environment can watch the webcast here on demand.