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Profiting with Sector ETFs

The Team to Beat

Profiting with Sector ETFs

November 14, 2007

 

SAN DIEGO (ETFguide.com) - On any given day exchange-traded funds (ETFs), such as the Energy SPDRs (Ticker: XLE) and the Financials SPDRs (Ticker: XLF) have trading volume that routinely outnumbers that of leading blue chip stocks. Whether it’s to hedge portfolio positions or to get convenient tax-efficient market exposure to a specific industry sector – it speaks to the fact that both individual and professional investors are on board with using these investment products to manage their portfolios.

 

The Select Sector SPDRs divide the S&P 500 into nine key industry sectors and investors can overweight or underweight specific sectors according to their financial goals. As of October 31st, 2007 the Sector SPDRs amassed just over $22 billion in assets.

 

Joining us is Dan Dolan, Director of Wealth Management Strategies at the Select Sector SPDRs to talk about it.

 

To date, the broader S&P 500 has recorded positive year-to-date (YTD) performance, what particular industry sectors are doing well?

 

DD: As of the close of business on 11/5, the S&P 500 is +6.00% with a wide range of good and bad under the surface. The Energy Sector continues to lead +28% YTD followed by Materials +21% and Technology having a solid year +20%. Seven of the nine sectors have a positive performance at or above the S&P 500. The broad index has been dragged down by two sectors – Financials -15% and Consumer Discretionary -8%.  The Financial sector is the largest slice of the market representing approximately 19% of the S&P 500. Technology, a former leader, is now second in market cap and closing the gap quickly.

 

Mortgage REITs and homebuilders have been hurt badly this year. The financials (Ticker: XLF) resilience to that downtrend seems to have been broken. To what extent will the financials performance be related to weakness in the homebuilders and REITs?

 

DD: The Financial Sector SPDR is down 15% YTD. Homebuilders and REITs are playing a part in this downtrend but only in a supporting role. The real story has been the large banks and broker/dealers that dominate this index. Their exposure to subprime and CDO liabilities is causing the pressure. Citigroup has lost the top spot in this index, replaced by Bank of America, as the largest financial company measured by market capitalization. Diversified financials, banks, brokers and insurance companies control 80% of this market segment. REITs represent approximately 6% and homebuilders are smaller.

 

After breaking the $700 share barrier recently, Google grabbed the headlines. What would be another way to participate in the movement of Google without spending north of $600 for one share?

 

DD: What do you do with Google at $600+ per share? I don’t know many investors who are comfortable with Google at this level but they still would like to own it. One alternative to closing your eyes and executing a buy order is a diversified basket of technology stocks with Google as a significant component. Most investors remember 2001 and the pain single stock exposure caused portfolios, particularly in the technology sector. The Technology Sector SPDR is composed of the 82 Tech and Telecom companies in the S&P 500. The index is market cap weighted. Google is already the 4th largest component with a weighting of almost 6%.  A position in XLK, trading around $28 per share, gives investors exposure to Google and 81 other Tech & Telecom components of the S&P.  It may be a more conservative approach to investing in GOOG.

 

Health Care stocks (Ticker: XLV) have been dragged down over the past few years by underperforming pharmaceutical stocks. If we are indeed in a recession, and some believe we are, health care could very well be a great defensive play.  

 

DD: Pharmaceuticals have been flat for the last 52 weeks with YTD performance of +3.00%.  This industry is trying but is having a difficult time turning performance around. If investors believe the economy is slowing and earning for growth industries will be more difficult, healthcare may be a place to look. It has always been viewed as a defensive sector and should perform better in a slowing environment. The long term question for healthcare, particularly pharmaceuticals, is new product development. With very large market caps and huge revenues, can these companies introduce enough new products to sustain growth? Blockbuster drugs are hard to come by.

 

As the year winds down, what type of tax saving or last minute investment tips should investors be looking at?

 

DD: The last few years have been good for most investors. This year is a bit mixed which offers us the opportunity to review accounts, particularly taxable accounts, and make year end adjustments. Investors should consult a tax advisor before entering into tax-related strategies. Some of these trades can add significant value to your portfolio.

 

Thanks Dan.