Cyclical Sector ETFs Can Perform In A Rising Rate Environment

by: Tom Lydon

The equities market is pulling back on speculation of the eventual Fed "tapering." However, the withdrawal from quantitative easing will go hand-in-hand with an improving economy, and Schwab analysts say cyclical sectors, along with related exchange traded funds, should behave "quite well."

"If the Fed begins to taper its purchases in keeping with an improving economy, we believe the market should ultimately behave quite well," writes Liz Ann Sonders, Senior Vice President and Chief Investment Strategist at Charles Schwab, for Barron's. "There has been some weakness in economic momentum recently, though the weakness has largely been among inflation readings."

A rising interest rate environment does not signal a top to a stock market's advance. According to Birinyi Associates, stocks continued to perform in the nine periods since 1962 when the yield on the 10-year Treasury rose over a sustained period of time.

Sondors, though, points to a rotation among defensive and cyclical sector stocks during this short-term correction.

Given the current environment, Schwab has upgraded their recommendations on industrials to join technology stocks as "outperform"-rated sectors. Consumer discretionary was also upgraded to "market perform."

  • SPDR Industrial Select Sector Fund (NYSEARCA:XLI)
  • iShares Dow Jones US Industrial Sector Index Fund (NYSEARCA:IYJ)
  • SPDR Technology Select Sector Fund (NYSEARCA:XLK)
  • iShares Dow Jones US Technology Sector Index Fund (NYSEARCA:IYW)
  • Consumer Discretionary Select Sector SPDR Fund (NYSEARCA:XLY)
  • Vanguard Consumer Discretionary Index Fund (NYSEARCA:VCR)

On the other hand, Schwab downgraded their recommendations on both utilities and consumer staples sectors to "underperform."

  • Consumer Staples Select Sector SPDR Fund (NYSEARCA:XLP)
  • Vanguard Consumer Staples ETF (NYSEARCA:VDC)
  • SPDR Utilities Select Sector Fund (NYSEARCA:XLU)
  • Vanguard Utilities ETF (NYSEARCA:VPU)

"The net is that we don't think the market is out of the woods in the near term, but we also believe any correction is likely to be less sinister than those that occurred during the past three years," Sonders added.

Max Chen contributed to this article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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