Sector benchmarks, financials, and high beta

“You cannot invest in an index” is the standard disclosure that accompanies any index returns when used as a performance benchmark. Therefore, I try to avoid the use of indexes whenever possible. To me, it makes much more sense to look at vehicles that you can invest in—such as index-based exchange-traded funds (“ETFs”). This makes ETFs such as the SPDR S&P 500 (SPY), iShares Russell 2000 (IWM), PowerShares QQQ (QQQ), and iShares MSCI EAFE (EFA) better performance representatives than their underlying indexes.

When analyzing U.S. sector performance, ETFs are once again the better choice. Contrary to many analysts, I do not base my sector analysis on the Select Sector SPDRs. To me, this family has two major shortcomings. First, the suite does not correctly represent all 11 sectors of the Global Industry Classification Standard (“GICS”). Instead, it tucks the stocks belonging to the Telecommunications sector inside the Technology ETF. Secondly, these ETFs limit their holdings to just the stocks within the S&P 500 Index, depriving investors of exposure to small- and mid-cap stocks.

In my opinion, the Vanguard suite of sector ETFs provide better benchmarks. They follow the GICS classification system and encompass more than 2,500 stocks, representing about 97% of the entire U.S. market capitalization. These 11 ETFs have combined assets of $100 billion, with the smallest one holding $1.4 billion. Additionally, they are all very liquid (highly tradeable) and carry an expense ratio of just 0.10% (except where noted). Vanguard introduced most of these ETFs in 2004 as alternative share classes to its sector mutual funds, which have an even longer history.

Listed in order of their percentage allocations of the U.S. market capitalization, the Vanguard suite of sector ETFs consist of the following:

Vanguard Information Technology (VGT): Representing about 20.0% of the U.S. market, this ETF currently holds 373 stocks and has a yield of 1.3%. Top industry allocations include Internet Software & Services 19.8%; Hardware, Storage, and Peripherals 15.3%; Systems Software 14.2%; Semiconductors 13.8%; Data Processing & Outsourced Services 11.4%; IT Consulting 6.6%; Application Software 6.0%; and Communication Equipment 5.6%.

Vanguard Financials ETF (VFH): Representing about 15.5% of the U.S. market, this ETF currently holds 402 stocks and has a yield of 1.9%. Top industry allocations include Diversified Banks 30.2%, Regional Banks 15.2%, Property & Casualty Insurance 7.7%, Asset Management & Custody 7.4%, Investment Banking & Brokerage 7.0%, Consumer Finance 5.5%, and Life & Health Insurance 5.5%.

Vanguard Health Care (VHT): Representing about 12.9% of the U.S. market, this ETF currently holds 367 stocks and has a yield of 1.5%. Top industry allocations include Pharmaceuticals 32.9%, Biotechnology 22.7%, Health Care Equipment 17.4%, Managed Health Care 10.6%, and Life Sciences Tools & Services 5.1%.

Vanguard Consumer Discretionary (VCR): Representing about 12.5% of the U.S. market, this ETF currently holds 386 stocks and has a yield of 1.3%. Top industry allocations include Internet & Direct Marketing Retail 16.0%, Cable & Satellite 10.5%, Movies & Entertainment 10.1%, Restaurants 10.0%, Home Improvement Retail 7.5%, Apparel Retail 4.8%, and Automobile Manufacturers 4.2%.

Vanguard Industrials (VIS): Representing about 10.9% of the U.S. market, this ETF currently holds 352 stocks and has a yield of 1.8%. Top industry allocations include Aerospace & Defense 19.7%, Industrial Conglomerates 19.1%, Industrial Machinery 10.2%, Air Freight & Logistics 6.2%, Railroads 6.4%, Construction Machinery & Heavy Trucks 5.6%, Airlines 5.5%, and Electrical Components & Equipment 5.1%.

Vanguard Consumer Staples (VDC): Representing about 8.2% of the U.S. market, this ETF currently holds 104 stocks and has a yield of 2.6%. Top industry allocations include Packaged Foods & Meats 18.8%, Household Products 18.1%, Soft Drinks 17.1%, Tobacco 15.3%, Hypermarkets & Super Centers 8.9%, and Drug Retail 8.1%.

Vanguard Energy (VDE): Representing about 7.0% of the U.S. market, this ETF currently holds 133 stocks and has a yield of 2.3%. Top industry allocations include Integrated Oil & Gas 37.8%, Oil & Gas Exploration & Production 28.5%, Oil & Gas Equipment & Services 15.7%, Oil & Gas Storage & Transportation 8.2%, and Oil & Gas Refining & Marketing 7.7%.

Vanguard REIT (VNQ): Representing about 3.9% of the U.S. market, this ETF targets the Real Estate sector, currently holds 157 stocks, has a yield of 4.0%, and comes with an expense ratio of 0.12%. Top industry allocations include Retail REITs 23.2%, Specialized REITs 15.8%, Residential REITs 15.5%, Office REITs 13.5%, Health Care REITs 11.9%, and Diversified REITs 7.3%.

Vanguard Materials (VAW): Representing about 3.4% of the U.S. market, this ETF currently holds 125 stocks and has a yield of 1.8%. Top industry allocations include Specialty Chemicals 22.6%, Diversified Chemicals 18.7%, Fertilizers & Agricultural Chemicals 9.3%, Paper Packaging 9.0%, Industrial Gasses 8.2%, Steel 7.1%, Commodity Chemicals 6.3%, and Construction Materials 5.0%.

Vanguard Utilities (VPU): Representing about 3.1% of the U.S. market, this ETF currently holds 77 stocks and has a yield of 3.6%. Top industry allocations include Electric Utilities 57.4%, Multi-Utilities 30.2%, Gas Utilities 5.7%, and Water Utilities 3.3%.

Vanguard Telecommunication Services (VOX): Representing about 2.4% of the U.S. market, this ETF currently holds 30 stocks and has a yield of 3.1%. Top industry allocations include Integrated Telecommunications Services 65.6%, Alternative Carriers 19.1%, and Wireless Telecommunications Services 14.9%.

Financials and High Beta Have the Edge

Last week, I tried an experiment by showing two weeks of EdgeCharts instead of the usual one. The feedback I received was positive, so I will continue the format today. The Financials sector, the High Beta factor, and the U.S. geography continue to provide the market leadership within their respective groupings.

Sectors: Financials has been on top of the sector rankings for eight consecutive weeks and still has a substantial margin over the competition. Telecom grabbed the second-place honors from Energy after a steady seven-week climb out of its former ninth-place spot. Two additional post-election winners, Industrials and Materials, continue to reside in the upper half of the rankings. Technology moved ahead of Consumer Discretionary, as both retailers and homebuilders came under selling pressure. The defensive sectors remain huddled near the bottom, and Real Estate lost its last inkling of positive momentum.

Factors: The factor rankings have been remarkably consistent for seven weeks, and all but the bottom two categories are in the same ranking order as last week. High Beta has been even more consistent, owning the leadership position for most of the past six months. Small Size and Value currently hold the second and third spots, which implies that the Small-Cap Value corner of the Morningstar Style Box is performing quite well. Dividend Growth, Quality, Yield, and Low Volatility were the dominant factors in 2015 and early 2016, but they have been relegated to the lower half of the rankings for a few months now. Yes, factor rotation is a real thing.

Global: The global rankings are visually different from the sector and factor rankings again this week. Even though all three are showing a wide dispersion of results, only the global rankings have four categories deep in the red. The U.S. has been on top for five of the past seven weeks, with Canada taking the top honors the other two weeks. After four weeks of being ranked no lower than second place, Canada has slipped to fourth today. Or did it? The Eurozone, World Equity, and Canada are all posting momentum scores of 13 today, resulting in a virtual three-way tie for second place, so don’t count Canada out just yet. EAFE, Japan, and the U.K. are in the middle of the pack and still clinging to small amounts of positive momentum. The bottom group in red are the same four categories as a week ago. However, Latin America posted a nice improvement that moved it two spots above its former last-place position. China slipped lower and now occupies the basement.


Note:

The charts above depict both the relative strength and absolute strength of various market sectors, styles, and geographic locations on an intermediate-term basis. Each grouping is sorted (top to bottom) by relative strength. The magnitude of the displayed RSM value is a measure of absolute strength, which is our proprietary method of measuring and reporting the intermediate-term strength as an annualized value.


“If you are in the right sector at the right time, you can make a lot of money very fast.”

—Peter Lynch

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