The U.S. stock market is rallying to new highs, consumer sentiment is rising and the U.S. housing market remains on a healing trajectory, but defensive sectors are leading the charge on the S&P 500, with health care, consumer staples and utilities bringing in the biggest year-to-date returns.
Historically, defensive stocks tend to outperform the broad equities market when investors perceive trouble ahead. But this time, investors still soldiering through the ultra-low-rate environment following the financial crisis are using sector-focused equity ETFs as the next best thing given the paltry yields in many parts of the bond markets.
"This year, there's something new happening, where nongrowth stocks are being pushed up toward growth multiples because of their ability to substitute for expensive bonds and return lots of cash," Joshua Brown, VP of investments for Fusion Analytics and an avid blogger, told IndexUniverse. "We are all aware of the long-term outperformance of lower-beta names, and we know that it works because people tend to overpay for growth and are inevitably disappointed as growth premiums fade."
Jonathan Citrin, founder of Birmingham, Mich.-based registered investment advisor CitrinGroup, goes a step further than Brown, calling the buying of sector funds the latest example of "irrational exuberance" in a market that is getting ahead of itself given shaky fundamentals.
"It's far more likely that negative real returns on sovereign debt coupled with considerably easy monetary policy has pushed many global markets to all-time highs," he said. "Investors willing to put money at risk are doing so out of an emotional greed, without tiptoeing into defensive stocks only."
Whatever the reason for the outperformance, investors who have bought into sector funds like the Health Care Select Sector SPDR (NYSEArca: XLV), up 19.6 percent year-to-date; the Utilities Select Sector SPDR (NYSEArca: XLU), up 18.3 percent year-to-date; and the Consumer Staples Select Sector SPDR (NYSEArca: XLP), up 17.5 percent year-to-date, have so far done better than those simply owning the S&P 500.
The SPDR S&P 500 ETF (NYSEArca: SPY) is up just 11.8 percent so far this year, even as it reaches record highs.
XLV, the health care fund, has by far been the most popular of the nine Select Sector SPDRs this year—a roster of funds that slice and dice the S&P 500 into nine sectors—with net inflows of more than $1.3 billion in roughly four months.
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