SPDR Sector & Equity Compass: Uncertainty Demands Diversification

In Q4, we consider those sectors that stand to benefit from the current inflationary environment and the prospect for rising rates, as well as those that can act as a buffer against downside risk. We also look at which geographical equity exposures may present opportunities given current valuations and political tailwinds, and how mid caps can help to diversify a portfolio.

More to be uncertain about this quarter

Compared with previous quarters this year, which could have been termed “recovery” or “reflation” or “passing the baton from US to Europe,” the coming quarter looks more difficult to predict.

We continue to believe that equities in general are supported by earnings forecasts, driven by continued reopening, and investors are still willing to buy any dip but are increasingly mindful of risks to growth and sentiment. Among the factors we are now taking into account are exposure to China (while still an engine of growth for many markets, it is increasingly a source of regulatory risk), rising input costs and the speed of tapering.

One answer to such uncertainties is to introduce diversification to portfolios. Investing in a sector or a regional index is the first step to help reduce idiosyncratic stock risk. Other factors to consider could be diversifying sources of return drivers or risk exposure (readily achievable through sectors, but also with different parts of the world, such as Japan), opting for lower correlation of performance between funds, or diversifying by size (as with mid-cap equities).