During the second quarter of 2021, SPDR SSGA US Sector Rotation ETF (XLSR) finished in positive territory and outperformed the S&P 500 Index. The fund finished the quarter with overweight positions in Industrials, Materials, and Technology.
Sector selection aided performance as positive contributions from Technology, Communication Services and Financials offset negative impacts from Materials, Industrials and Consumer Discretionary. Strong sales expectations, favorable balance sheets and positive macro scores anchored our positive forecast for Technology, which we held an overweight to throughout the quarter. The sector benefited as growth began to outperform value in the second half of the quarter and this position led to the largest source of relative and absolute outperformance. Compelling price momentum had aided Financials in our models, but a significant degradation in sales estimates weighed on the sector in June and the position was reduced. Given higher long-term yields early in the quarter, Financials outperformed on a relative basis during the period it was held. We held a targeted overweight to Communication Services through May given strong sentiment and quality attributes along with beneficial valuations. The allocation positively contributed to relative performance. We became overweight to Industrials in May and held an overweight to Materials for the quarter, but both sectors underperformed relative to the S&P 500 as the US dollar strengthened, detracting from performance.
Portfolio Positioning and Outlook
Our near-term outlook continues to favor equities over most other broad asset classes. From a regional perspective, we prefer US equities, which have remained resilient, notwithstanding some potentially underappreciated tax risks.
The Federal Reserve’s hawkish surprise at its June FOMC meeting certainly caused some recalibration around the future path of short-term interest rates, but it also served as a catalyst to reinforce a rebound in growth-oriented equity sectors like Technology, Communication Services and Consumer Discretionary. In XLSR, our top overweight sectors are Technology and Industrials with more moderate overweight allocations to Materials, Consumer Staples, Financials and Energy. Our deepest underweights can be found in the Health Care, Consumer Discretionary and Communication Services sectors. The most notable change in our views from the latest rebalance has been a shift away from Materials and into Consumer Staples.
The recent slide in longer term interest rates has benefited technology stocks and helped spur a sharp uptick in short-term price momentum. Strong earnings and sales sentiment, salutary balance sheets and reasonable valuation factors propel Technology into the top spot in our quantitative framework.
Furthermore, thematic tailwinds, such as work from home and technological innovation, should continue to support the Industrials score across all factors except value, boasting strong long-term price momentum and demonstrating solid earnings and sales expectations. The Materials sector has moved from a strong overweight to a modest overweight allocation as mining firms followed gold and copper prices lower — contributing to a deterioration in short-term momentum metrics. Consumer Staples provides some useful diversification properties compared to some of the higher beta sectors held in the portfolio and sentiment factors associated with expected earnings and sales growth have also been reviving. Although Financials had previously exhibited some deterioration in top-line sales growth expectations, its ranking in our models has stabilized and we maintain a small overweight position. Improvements in economic growth have propelled Energy up in our sector rankings, owing to strong long- and short-term price momentum, beneficial sentiment scores and attractive valuations.
Sectors such as Consumer Discretionary and Health Care continue to score poorly in our quantitative framework. High debt loads and steep valuations continue to weigh on our outlook for Consumer Discretionary, although sentiment toward the sector has been improving. For Health Care, weak price momentum and earnings sentiment are the key factors pointing toward a less favorable outlook. The Communication Services sector has recently benefited from the rebound in growth exposures, but credit market signals suggest the advance may have come a bit too far and we’ve reduced our exposure as a result.
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
Real Estate Investment Trust (REIT)
Companies that own and operate commercial properties, such as office buildings and apartment complexes. S&P 500 Index A benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
The weighting of a given security, industry or market sector that exceeds the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
The weighting of a given security, industry or market sector that is less than the weighting assigned that security, industry or sector in a relevant benchmark or benchmark portfolio.
S&P 500 Index
A benchmark for U.S. large-cap equities that includes 500 companies from leading industries and captures approximately 80% coverage of available market capitalization.
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The views expressed in this material are the views of the Investment Solutions Group through the period ended June 30, 2021 and are subject to change based on market and other conditions. This document contains certain statements that may be deemed forward-looking statements. Please note that any such statements are not guarantees of any future performance and actual results or developments may differ materially from those projected
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