Use these ETFs to take advantage of sector rotation

However, the 2010-2020 decade saw a dramatic reversal and tech stocks came roaring back to life. The Nasdaq soared 258%, while the S&P 500 energy sector index posted a modest return of 3%. If you had taken a “set it and forget it” approach, you would have missed out on a historic bull market.

Takeaway: Understanding and taking advantage of sector rotation can be a game-changer for your investment portfolio, and ETFs offer a versatile way to gain targeted exposure.

Sector rotation strategies take advantage of long-term economic cycles. As the economy expands and contracts, different sectors perform better or worse, depending on their sensitivity to economic growth, inflation and interest rates.

S&P 500 sector performance by year – source: Novel Investor

In the chart above, you can see that the S&P 500 has average performance in most years, but a few sectors have outperformed the benchmark. This suggests that there is some alpha available for investors who pay attention to macroeconomic trends and adjust their portfolios accordingly.

Cyclical sectors such as the consumer goods sector, financial sector and industrial sector develop during periods of strong growth. When consumers are confident in their financial prospects, they spend more on non-essential goods and services, helping consumer businesses. At the same time, a strong economy stimulates bank lending and increases demand for industrial products to meet growing needs.

But when the economy begins to overheat, the Federal Reserve raises interest rates to stem inflation. Rising interest rates put pressure on cyclical sectors as borrowing costs rise and consumer spending falls. This dynamic helps defensive sectors such as health care, consumer staples and utilities, which are less sensitive to interest rates, while energy and materials sectors benefit from higher prices.

In today’s economy, the Federal Reserve is struggling to contain high inflation without causing a recession. Economic growth remains strong, but there is a risk that the central bank restricts lending too much or too soon. Meanwhile, stock valuations seem stretched (particularly in the tech industry), which means investors may be overly optimistic. As a result, a change in the business cycle may appear on the horizon.

The SPDR Select Sector ETFs are the most popular option for a stock sector rotation strategy. For example, during the bull market of the last 52 weeks, Discretionary consumer sector SPDR Fund (XLY) increased by almost 18% compared to just 4.6% for Consumer Staples Select a sector SPDR Fund (XLP) i Technology Select a sector SPDR Fund (XLK) increased by about 40% compared to less than 10% for Tools Select a sector SPDR Fund (XLU).

BondBloxx offers the same sector rotation approach for bonds. For example BondBloxx USD High Yield Bond Sector: Telecommunications, Media and Technology ETF (XHYT) offers exposure to high-growth technology-focused companies, while BondBloxx USD High-yield non-cyclical consumer bond sector ETF (XHYD) provides exposure to more defensive consumer products companies. However, it is important to remember that bond prices behave differently – what is bullish for stocks may not be bullish for bonds.

If you want a more hands-off approach, several actively managed ETFs offer built-in sector rotation. You get the benefits of cross-sector diversification and focusing on sectors that are more likely to outperform in the current or upcoming economic cycle.

These ETFs are selected based on since the beginning of the year total return which ranges from 0.1% to 9%. The AUM ranges from $5.5 million to $1.6 billion, and expenses range from 0.42% to 1%. Currently, the profitability ranges from 0% to 6.9%.

• The SPDR SSGA Sector rotation in the US ETF (XLSR) is active ETF that combines quantitative and qualitative analysis to tactically allocate capital between different sectors.

• BlackRock industry turnover in the US ETF (INRO) is active ETF which provides low-cost exposure to industries that portfolio managers believe are well-positioned to outperform based on forward-looking analysis.

• Main sector rotation ETF (SECT) is active ETF which seeks to outperform the S&P 500 in emerging markets while limiting losses during declines.

• BondBloxx USD High-performance sector rotation ETF (HYSA) is active ETF which trades between various BondBloxx sector funds. It currently has a quarter of its assets in the industrial sector and a fifth in the telecommunications, media and technology sectors. Meanwhile, it is 7.3% on a 30-day basis KNOT the rate of return may be attractive to income investors in today’s interest rate environment.

When deciding between these options, investors should carefully consider the fund’s performance and cost, as well as the impact on portfolio diversification.

Sector rotation strategies allow you to generate alpha in your portfolio while maintaining diversification across multiple stocks and industries. With several stock and bond sectors ETF options, it’s easier than ever to create custom strategies in your portfolio. Alternatively, actively managed sector-rotating ETFs can help you benefit from these trends without having to manage your exposure over time.