Insights

SPDR® SSGA US Sector Rotation ETF (XLSR) – Q1 2022 Commentary

During the first quarter of 2022, XLSR outperformed the S&P 500 index. The fund finished the quarter with overweight positions in Technology, Consumer Staples, Materials, Financials and Energy.



Performance

All equity sector overweight allocations, with the exception of an overweight to Technology, contributed to outperformance in Q1. The biggest contributor was an overweight to the Energy sector which was held for most of the quarter and advanced by nearly 30% for the period it was held.1 Energy continued to benefit from strong demand and sticky inflation. Additionally, Russia’s invasion and subsequent sanctions propelled oil prices higher due to potential supply disruptions. A consistent allocation to the materials sector also helped performance as metal and mining firms advanced alongside commodity prices. Similarly, a persistent allocation to Financials aided relative returns as the sector finished down, but outpaced the S&P 500. Technology ranked well in our modeling from favorable sales and earnings sentiment and beneficial longer-term price trends. However, the sector is sensitive to rising rates and with market expectations for a very hawkish Fed increased, Technology finished well below the S&P 500 and dented returns.

Fund Performance

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Portfolio Allocations

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Portfolio Positioning and Outlook

The macroeconomic environment is less certain than it was entering 2022. Despite solid underlying fundamentals, ongoing supply shortages and elevated commodity prices will keep upward pressure on inflation and the longer it persists, the more impactful the hit on demand will be. The risks point to lower growth, but at present, we are not forecasting a global economic downturn and still expect economic growth to remain positive.

Our equity modeling continues to point to positive, albeit modest, equity returns ahead. To be sure, expected returns for global developed equities are even a scant few basis points above historical averages. A greater scrutiny will reveal however that those same returns expectations have weakened meaningfully from where they stood at the start of the year. Certain aspects of our modeling, including a broad set of macroeconomic factors, sentiment as well as momentum indicators have been dampening our expected returns in equities for quite some time. But the weakness across those indicators has intensified in 2022, off-setting improvements in valuation factor which incidentally remain in neutral territory. Regionally, we prefer the US where improving quality factors, mainly a better return on assets and lower volatility, help offset rich valuations. Elsewhere, strong macro scores, positive sentiment and firm price momentum underpin our constructive outlook.

From a sector perspective, our forecast for Technology continued to weaken with the sector falling down our rankings and now an underweight. We continue to favor Energy, Financials, Materials and the outlook for utilities has improved. Longer-term price momentum supports technology, but shorter-term measures are weak and the large deterioration in sentiment and unattractive valuations has soured our outlook. The Energy sector benefits from robust price momentum as oil prices have benefited from superb supply and demand fundamentals and supply disruptions from the Russian invasion. Valuations still appear enticing while healthy earnings and sales estimates further buttress our optimistic forecast. Materials score well across all factors we monitor with advantageous price momentum, sturdy sentiment and attractive valuations buoying the sector. Financials rank well across most factors with reasonable valuations and healthy sales and earnings estimates offsetting poor quality factors. Additionally, price momentum has softened, but remains contributory. Utilities owes its upgraded outlook to strong price momentum, which has become more supportive. Valuations for utilizes are neutral, but sentiment factors, while still negative, have improved.

Market Regime Forecasts

The Market Regime Indicator (MRI) employs a quantitative framework and forward-looking market indicators, including equity- and currency-implied volatility, as well as credit spreads, to identify the current market risk environment. Tracking risk appetite shifts in the market cycle helps frame tactical asset allocation and volatility targets.

A Look at the MRI

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