Spotting Trends: 3 Sectors to Consider in Q4

Written by: Matthew J. Bartolini, CFA | State Street Global Advisors 

As investors scour the landscape for return-generating opportunities, being able to spot trends is a significant advantage. However, it’s not enough to simply spot overarching market shifts or dynamics. True opportunity lies in using specialized, industry-specific knowledge to capitalize on market events, macro trends, and other changes. As we enter the final quarter of 2019, we see three opportunities where we believe investors can benefit from tactical positioning in sector-based strategies.

1. Add advanced security defense to portfolios

As businesses have become more dependent on the digital economy and the internet for their day-to-day operations and long-term growth, cyberattacks and data fraud or theft are now two of the top five risks CEOs are most likely to face.1 Global spending on information security is projected to grow at a compound annual growth rate of 9.2% between 2018 and 2022, reaching $133.8 billion.2 Spending Security Sectors The nature of warfare and border security threats has also evolved, driving the increase in government spending on militarized AI and unmanned and autonomous capabilities to protect national security. Worldwide spending on militarized artificial intelligence (AI) is projected to rise to $118 billion by 2023.3 Firms specializing on the cutting edge of security in cyberspace and geospace may benefit from the increasing demand for security services and technology. Relative to a traditional aerospace and defense exposure, which is 100% allocated to industrial firms, the SPDR® S&P Kensho Future Security ETF (FITE) is 37% allocated to Software & Services firms and 18% allocated to technology hardware, better harnessing future developments in national and enterprise security.4

2. Capture the potential rebound in housing markets

Last year, homebuilders underperformed the broad market by nearly 30% as rising interest rates dampened the demand of homebuyers. However, headwinds are turning into tailwinds this year. Falling 30-year mortgage rates and the Federal Reserve’s dovish monetary stance have boosted housing activity and homebuilder sentiment and lifted homebuilder stocks, as shown in the chart below. Homebuilder Mortgage Rates The total of new and existing home sales has rebounded from the bottom since January and exceeded the previous peak in June 2017.5 Homebuilder sentiment, as measured by the NAHB/Wells Fargo Housing Market Index, picked up for the sixth straight month.6 These positive industry trends helped homebuilders deliver upbeat earnings results in Q2 and drove positive estimate revisions for 2019 and 2020.7 A strong labor market, rising wages, and favorable demographic changes are likely to continue supporting housing demand and homebuilders’ earnings growth. The homebuilders’ comeback may still have legs, as the industry is trading within the bottom quartile over the past 10 years based on trailing and forward price-to-earnings.8 To position for the decline in home-financing cost and supportive housing trends, investors can consider an allocation to SPDR® S&P® Homebuilders ETF (XHB).

3. Make a value play with a defensive nature

Health Care has been the worst-performing sector in 2019, as regulatory pressures related to drug pricing, insurance, and the opioid crisis have increased as the election draws nearer. This has weighed down the sector’s valuations to the lowest level since 2016 and made it the least expensive sector in the S&P 500® Index.9 Earnings Revenue Despite these issues, the sector has delivered strong growth and beaten analyst expectations by a large margin during the first two quarters of 2019. That’s expected to continue, with Health Care predicted to post positive growth for the rest of 2019. On the other hand, earnings growth in the broader market has turned negative, with continuous downward revision amid global trade uncertainty and economic slowdown. Thanks to its noncyclical business, Health Care historically outperformed the broader market in six of seven US recessions by an average of 10% and in eight of 11 slowdowns by an average of 5% on a cumulative basis since 1960. This provides a strong defensive exposure in the current slowdown environment.10 The recent impeachment inquiry into President Donald Trump might derail the bipartisan efforts to lower drug prices, partially reducing the near-term regulatory risk and potentially helping investors position defensively heading to the year-end. For investors seeking to add defensive exposures with strong earnings sentiment but without overpaying for valuations, consider an allocation to the Health Care sector with the Heath Care Select Sector SPDR Fund (XLV). To learn more about emerging sector investing opportunities, read our quarterly piece, Sectors & Industries: Spotting Trends or visit our dedicated sector webpage.
1The Global Risks Report 2019, World Economic Forum. 2IDC, Worldwide Semiannual Security Spending Guide, March 2019. 3IDC Worldwide Semiannual Artificial Intelligence Systems Spending Guide 2018H2. 4FactSet, as of 09/31/2019. 5FactSet, as of 09/25/2019. 6National Association of Home Builders, 09/17/2019. 7FactSet, as of 09/25/2019. 8FactSet, as of 08/31/2019. 9FactSet, as of 09/25/2019, based on the 15-year percentile ranking of forward price-to-earnings ratio. 10Sector Business Analysis, State Street Global Advisors, November 2018. 11The gross expense ratio is the fund’s total annual operating expenses ratio. It is gross of any fee waivers or expense reimbursements. It can be found in the fund’s most recent prospectus. 12State Street Global Advisors Funds Management, Inc. (the “Adviser”) has contractually agreed to waive its advisory fee and reimburse certain expenses, until January 31, 2022, so that the annual Fund operating expenses of the Fund are limited to no more than 0.1345% of the Fund’s average daily net assets (exclusive of non-recurring account fees and expenses). This contractual fee waiver and/or reimbursement does not provide for the recoupment by the Adviser of any amounts waived or reimbursed. The Adviser may continue such waiver and/or reimbursement from year to year, but there is no guarantee that the Adviser will do so after January 31, 2022. The waiver and/or reimbursement may not be terminated prior to January 31, 2022 except with the approval of The Select Sector SPDR Trust’s Board of Trustees.
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