This commentary originally appeared on Dec. 27 on ETF Profits -- to access all the strategies from our team of ETF professionals, click here.
The S&P 500 is broken into 10 major sectors that many professional investors use for asset allocation and risk analysis -- and, like many equity strategists, I maintain my own sector model that's based on these. When I last published this model in July, I was becoming more defensive as I looked toward an uncertain and volatile second half. As such, I was favoring the healthcare, information technology and utility sectors, and I upped my allocation to consumer staples, as you'll see on the table below.
I am now more positive on the equity markets, so -- with the exception of IT -- I'm going underweight on all of the sectors I just mentioned. These, by the way, were the best-performing groups in 2011, having returned between 11% to 14% in a broad market that was pretty flat for the year.
Meanwhile I'm switching to overweight, or adding to my positions, in sectors that have lagged in the second half: consumer discretionary, energy, IT and materials. I'm also keeping a small overweight in the financial sector, which I continue to believe has been oversold. As such, my favored equivalent sector ETFs are now the Consumer Discretionary Select Sector SPDR (XLY), the Energy Select Sector SPDR (XLE) and the Vanguard Information Technology ETF (VGT). Below is the revised model, as of Dec. 26.
My reshuffling reflects my broader views on the markets, which I see moving up modestly in the first half of next year. I believe the chance of another recession has subsided, and I project global gross domestic product growth of 3% to 4%, driven by strong growth in Asia (outside of Japan) and in emerging markets. It now appears the U.S. will see moderate growth after a strong fourth quarter in 2011, and that only Europe will suffer a slowdown. I also believe we will see modest but positive political moves in the U.S. and Europe -- more specifically, it appears likely that the payroll tax cuts will eventually be extended for the full year in the U.S., and that we'll see continued action in Europe to deal with the debt crisis.
In this environment, I believe consumer confidence and spending will improve, which bodes well for the consumer discretionary sector -- and, as a result, for XLY. U.S. holiday sales are projected to climb 4%, and it appears U.S. consumers have built up demand and that their confidence is rising, given the better recent numbers in the housing and labor markets. Also driving demand is the mushrooming collective middle class in the faster-growing emerging-market nations -- which, in turn, will play to the advantage of many the large-cap U.S. multinational consumer names in XLY.
As for XLE, I believe a renewal of global growth, supply shortages and continued uncertainty in oil-producing nations will benefit the fund as these factors push crude prices and energy stocks higher. Energy saw strong gains in early 2011, and gave most of these back in the third quarter. However, stocks in the space have firmed up recently, and XLE appears to have harnessed the first leg in the next move higher.
Finally, I favor large-cap domestic technology space, as represented by VGT -- because, out of all the S&P sectors, the stocks in this one have the most attractive valuations vs. growth opportunities. These companies are also positioned to benefit from pent-up demand, which should drive increased corporate and consumer spending in the U.S. In addition, the biggest companies in VGT are generating an important component of overall revenue, top-line growth in the fastest-growing emerging-market countries.
A final note on my choice of sector ETFs: The most popular sector funds are the nine Select Sector SPDRs, but Information Technology Select Sector SPDR (XLK) encompasses the telecommunications-services names, so there are only eight pure Select Sector SPDRs that I use for sector-based exposure. I prefer Vanguard ETFs for pure exposure to IT and telecommunications, as they are based on broader MSCI indices, which assign stocks to the same S&P sectors.