Why SPY? ETFs and Sector Analysis

Joon Choi Senior Portfolio Manager, Research Analyst, Systems & Forecasts

February was a very strong month for equities as the S&P 500 Index advanced 3.72% for the month which is the 10th best February performance since 1950, observes Joon Choi, contributing editor to Systems & Forecasts.

In addition, the first two months in 2017 were up and this may be a sign of further equity gains for the rest of the year. Here, I will discuss the significance of starting out the year with two positive months and shed some light to which sector may provide the best opportunity during the ensuing 10 months.

The S&P 500 Index (price only) gained an average of 7.7% with a batting average of 73.1% (% of winner) from March to December since 1950. However, the average gain shot up to 12% when the first two months recorded positive returns with almost 92.3% winners.

In comparison, the average return falls to 5% with a 61% batting average when the index does not advance in each of the first two months. This suggests that further gains in the equity markets are very likely for 2017.

I prefer to invest in the SPDR S&P 500 ETF Trust (SPY) over other ETFs unless there is a compelling reason to choose a different vehicle.

However, I wanted to determine if certain sectors provide a better investment opportunity during the favorable 10-month period mentioned above. Hence, I gathered total return data of SPY and the other nine sectors.

Since 1990, there were eleven years when the S&P 500 Index showed positive returns in the first two months. Five out of the nine sectors outperformed SPY’s average return of 14.6%.

Healthcare SPDR (XLV) had the best return (19.4%), while Materials Select Sector SPDR (XLB) experienced the lowest average return (7.8%).

However, when the results are adjusted for risk (using SPY as the benchmark), only two ETFs performed better than SPY — Utilities SPDR (XLU) and Consumer Discretionary SPDR (XLY), with gains of 17.4% and 16.5% respectively.

Although XLU had the highest risk adjusted return, I do not feel comfortable investing in the sector as potential interest rate hikes this year may become a headwind.

On the other hand, XLY had a better average return than SPY (for both with and without risk adjustment). Furthermore, the ETF outperformed SPY 9 out of 11 years; 1995 & 1996 were the years of underperformance.

The S&P 500 Index’s positive returns in January and February suggest that equities are very likely to advance over the next 10 months.

SPY would be the investment of choice to capitalize on this phenomenon; however, consumer discretionary may be an alternate choice as it outperformed SPY approximately by 2% a year.

Conversely, XLB should be avoided as it lagged SPY by almost 7% (7.8% vs. 14.6%), and fared even worse when adjusted for the volatility.

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