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Sector ETF Reaction to Budget Impasse

It has been five trading days since “no-taper” euphoria has passed. In that time, U.S. stock assets have been falling, though the declines have been modest. Most investors continue to believe that a last-minute deal will be struck and that a bearish retreat like the 2011 correction is improbable.

Nevertheless, different economic sectors appear to be responding differently to the current landscape. And while previous blueprints for budget uncertainty may have favored non-cyclical segments such as health care and consumer staples, old-school rules may not be applicable.
Sector Performance During 5-Day Downturn

Approx %

SPDR Select Sector Technology (XLK) -0.6%
SPDR Select Sector Industrials (XLI) -0.7%
SPDR Select Sector Utilities (XLU) -0.9%
SPDR Select Sector Energy (XLE) -1.0%
SPDR Select Sector Consumer Discretionary (XLY) -1.1%

SPDR S&P 500 (SPY) -1.2%

SPDR Select Sector Healthcare (XLV) -1.9%
SPDR Select Sector Materials (XLB) -1.9%
SPDR Select Sector Consumer Staples (XLP) -2.3%
SPDR Select Sector Utilities (XLF) -2.3%

Granted, assets like SPDR Select Sector Materials (XLB) and SPDR Select Sector Financials (XLF) may be following the risk-off rules of investment anxiety. Nevertheless, it is rare to find safer havens like Health Care (XLV) and Consumer Staples (XLP) near the bottom of the barrel. Equally strange, it is a bit ironic to find economically sensitive Industrials (XLI) at the top of the leaderboard, let alone a volatile segment like Technology (XLK).

Since the budget impasse has been tied to Obamacare, I suspect some of the selling in XLV may be associated with uncertainties here. And perhaps the move away from Consumer Staples (XLP) is related to an expensive sector with poor earnings prospects. Yet I am still surprised how Energy (XLE), Industrials (XLI) and Tech (XLK) can lead the pack in the face of rancorous non-negotiations as well as subdued profit expectations.

Warren Buffett recently claimed that he is having a difficult time finding ANYTHING to buy. What’s more, he is sitting on $49 billion in cash. Should we call this “de facto market timing?” If Buffett cannot find anything to purchase — if the Oracle of Omaha maintains that he does not see bargains after a four-and-a-half year run-up — why are economically sensitive conglomerates in the Industrials space holding up so well? It would be tough to argue that Industrials (XLI) are inexpensive with a trailing P/E of 18.9, an optimistic Forward P/E of 16.4 and a price-to–book (P/B) of 3.3.

XLI 50 200

Investors should also be mindful of the fact that, even if the flatness of corporate revenue is of little concern these days, and even though short-term solutions for the budget as well as the debt ceiling are likely to emerge, the Federal Reserve’s “no-taper” decision probably injected even more uncertainty into the investing picture. Whereas some believe the decision to wait was a pleasant surprise, it only raised doubts surrounding Federal Reserve communication. Now, nobody really knows what to expect from the Fed; now, central bank decisions are not merely data-dependent, they’re also dependent on political outcomes.

For example, does the market now believe the Fed will keep on “keeping on.” Long-dated bonds are having a splendid week, with Vanguard Extended Duration (EDV) logging 3.1% and iShares 20 Year Treasury (TLT) pocketing 1.7%. This could have as much to do with the budget impasse as anything else, but the truth is, the Fed’s efforts at enhanced communication has only led to greater ambiguity.

I remain committed to equities, with allocations to highly liquid ETFs such as Vanguard Dividend Growth (VIG), Vanguard International ex U.S. (VEU) and iShares Small Cap Value (IJS). I am also “overweight” tech at this time with funds like Vanguard Information Technology (VGT) or First Trust NASDAQ Tech Dividend (TDIV). That said, like Mr. Buffett, I have been patient for months with some cash on the sidelines. I would be willing to buy into meaningful market weakness. However, if long-term trends break and stop limit loss orders hit, clients may have even more cash to protect against catastrophic bear market losses.

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