Our Favourite ETF Sector Trades – 25 October 2021 Update
- By John Tierney
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- 5 min read
The S & P 500 has climbed 4.5% from the early October low, on the elixir of good earnings that (so far) more than offset the negative message of the Atlanta Fed GDPNow projection of a meagre 0.53% 3q GDP print. Other consensus forecasts from the Conference Board and Blue Chip Economic Indicators are in the 3.5% range. Given ongoing signs that the US and global economy are slowing even as the Fed signals that it is on track to starting tapering its bond purchase program consensus forecasts may well fall further.
In normal times a slowing economy should not bode well for equities – but these are hardly normal times. If many companies are able to up productivity due to labour shortages and manage to gain some pricing power due to ongoing supply constraints earnings in coming quarters could be surprisingly robust. Over the next week there will be a heavy load of earnings coming, which could do much to show whether a broad swathe of companies can indeed perform even as the supply lines and the broader economy struggle.
There is also a reasonable prospect that Congressional democrats may finally move ahead on the $1 trillion infrastructure bill and President Biden’s infrastructure and social bill, price tag still to be determined. Steady progress should bolster equity markets; but should differences among Democrats again stymie efforts to reach consensus markets could well falter.
All our positions remain unchanged:
- In the S&P 500, we stay constructive on growth versus value. We see little prospect of value outperforming while the labour market remains weak.
- Financials and banks have rallied as the 10Y Treasury yield moved above 1.6% but maintain our underweight, particularly in banks versus SPY due to moribund loan growth.
- Homebuilders have struggled against the broader market, but underlying fundamentals remain robust due to low rates and tight housing supply.
- We stay negative on retail. It is losing a key source of support as extraordinary unemployment benefits expire and spending slowly returns to services.
- We are temporarily negative on our clean energy ETF trades. The upcoming climate change meetings in Glasgow may well be long on paper commitments to cut emissions but we doubt many countries will actually do much to make good on those commitments for now. Any selloff should be a buy opportunity. We stress this is a longer-term and patient trade.
Table 1 shows the performance of our sector trades since inception.
We summarise our latest thinking on each sector view in the remaining sections.
S&P 500 Growth (L) vs Value (S)
Initiated 26 April 2021 After initially struggling, growth has outperformed value by 5.9%. We do not see growth running away from here, but value will continue to underperform while businesses cannot hire enough workers. For smaller companies to thrive, we need sustained improvement in labour force participation.
Long SPY / Short XLF
Initiated 20 May 2021 We remain bearish on financials due to the low interest rate environment and ongoing Fed QE program. The broad XLF ETF is about flat to SPY now given rising rates and possibly signals from the Fed that it may soon start tapering its QE program.
Long SPY / Short KRE (Regional Banks)
Initiated 20 May 2021 We are particularly bearish on banks, as they bear the brunt of the Fed’s QE policy. Regional banks have performed particularly poorly, down 17.4% so far, as they struggle to grow their loan portfolios in the face of weak demand.
Long SPY / Short KBWB
Initiated 20 May 2021 Major banks have performed somewhat better than regionals due to a strong earnings season and more diversified revenue streams, particularly investment banking and trading. Still, they remain at risk of underperforming due to weak loan growth. Also, banks cannot benefit much from rising rates until the short end rises, and there is little prospect of that happening any time soon.
Long XLF / Short KBWB
Initiated 20 May 2021 For investors interested in a long/short trade within the financial sector, we suggest being long broad financials, which includes banks, insurers, asset managers and payment companies, and short banks, whether majors or regionals.
Long XHB / Short SPY
Initiated 28 May 2021 We recommended going long homebuilders on the strength of the housing recovery, low rates, and a housing inventory shortage. We view the softness in homebuilders as an opportunity to add to positions. There is some risk of rising mortgage rates when the Fed slows purchases of MBS, but underlying fundamentals are still attractive.
Long SPY / Short XRT
Initiated 10 June 2021 Retail sales received a huge boost during the pandemic because people needed stuff, generous unemployment benefits gave them money to spend, and spending on services collapsed. Those benefits are expiring, which should hurt retail sales especially as employment is rising too slowly to offset the loss of income. Consumption spending is also slowly returning to services.
Clean Energy
After the IPCC report on climate change came out, we proposed several trades in the clean energy sector.They performed poorly during the market selloff of late September and early October, but have rallied strongly since.
Clean energy ETFs may continue to find support as the global climate change conference starts in Glasgow. There will doubtless be positive spin coming out of the meetings but the big question is whether and when more serious money starts to flow into the clean energy sector.
We expect many countries will be slow to start honouring their commitments, which could put downward pressure on clean energy equities.
But as ongoing evidence of climate change mounts we expect the money will start to flow.
We recommend investors start accumulating positions in clean energy ETFs. We stress this is a patient trade but over the coming decade, we see significant upside in this sector.
Long SOXX / Short SPY or QQQ
Initiated 6 October 6, 2021 The semiconductor industry has been in the news frequently in 2021 due to tight supplies that have hamstrung the auto industry in particularly. This stems from a surge in demand for digital consumer products since the pandemic hit in March 2020
The industry is enjoying pricing power for the first time in 30 years. Further, demand is likely to remain strong in coming years as electric vehicles and other clean energy technology comes online. We think semiconductors can outperform the broad equity (SPY) and tech (QQQ) markets over the medium term
Over a 30-year career as a sell side analyst, John covered the structured finance and credit markets before serving as a corporate market strategist. In recent years, he has moved into a global strategist role.
(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)