The Federal Reserve’s loose monetary policy and resulting low interest rates have pushed many investors to shift their asset base to riskier investments. This is evident from the heavy inflow of assets in equities in 2013. As a result, most of the equities have moved higher only to break records or reach new highs.
This increased focus of investors in risky assets also bears testimony to the recent rally on Wall Street. The month of March has been pretty good for the U.S. stock market as the Dow Jones Industrial Average, experienced a ten day winning streak, the first time such a streak has taken place in decades.
Furthermore, the broad S&P 500, as represented by the SPDR S&P 500 ETF (SPY), also was moving higher and is now just a few points below its Oct 9, 2007 peak. This kind of stock price movement is pretty rare in the history of Wall Street, and has signaled to many that a new bull market is underway.
A Glimpse on Valuation
However, in an attempt to go higher and reach above the all-time highs, the valuation of the S&P 500 has resultantly crept higher. The P/E ratio of S&P 500 currently stands at 16.25 (Forget SPY, Focus on Mid and Small Cap ETFs).
On the contrary, investors should note that two sectors that started the year on a strong note and still continue to reward investors with huge gains have cheaper valuations as compared to the broader market index.
Financials and energy are the two sectors that have not only provided investors with a handful of profits but are also pretty inexpensive compared to other industries.
In particular, Financial Select Sector SPDR (NYSEARCA:XLF) and Energy Select Sector SPDR (NYSEARCA:XLE) have both performed remarkably well since the start of the year and continue to deliver strong gains.
In fact, both ETFs have beaten the S&P 500 in terms of year-to-date gains. While S&P 500 has gained 9.43% in the year-to-date period, XLF returns stand at 12.57% while XLE has returned 11.45%.
Indeed it is not just the multi-year gains which are attracting investors towards XLF and XLE. These sectors are also two that have relatively modest valuations that are attracting investments. Both XLE and XLF appear to be cheap relative to the broader U.S. market as indicated by their respective P/E ratios (Time to bank on Regional Bank ETFs).
XLF highlights the low valuation of financial stocks and has a P/E ratio of 12.36, while XLE provides exposure to energy stocks has a P/E of 12.89.
A Quick Look at the Financial Sector ETF
XLF was one of the best performing ETFs in 2012 attributable to the strong performance of banking stocks in the last one-year period. The ETF started the year on a strong note further fueled by strong earnings posted by most of the U.S. banks (Banking ETFs 101).
Progress seen in the past one year gives a clear growth indication for the U.S. banking sector. Besides contraction in provisions for credit losses and cost containment, a marked recovery in the equity markets and consequent revenue growth led most of the banks to report higher-than-expected earnings. Expanding consumer credit and overall improvement in lending activity made it easy for the banks to sustain the improvement.
In fact, U.S. banks are poised for further growth in 2013 with uninterrupted expense control, sound balance sheets, an uptick in mortgage activity and lesser credit loss provisions.
Moreover, a favorable equity and asset market backdrop, progressive housing sector and an accommodative monetary policy are expected to make the road to growth smoother (Homebuilder ETFs: Can the Rally Continue?).
However, it should also be noted that though improved economic data such as higher consumer spending and gross domestic product (GDP), improving housing market and a declining unemployment rate point towards optimism, a paltry interest-rate environment is disturbing for the sector.
In such a scenario, an investment in XLF seems prudent with financial stocks exhibiting cheaper valuations. XLF is one of the popular ETFs tracking the financial sector and has been in the limelight attributable to its remarkable performance. The ETF is continuously trying to break out from its highs post-crisis.
The fund manages an asset base of $7.6 billion and trades at volume levels of more than 49 million shares a day.
XLF is home to 83 financial stocks with JPMorgan Chase, Berkshire Hathaway and Wells Fargo comprising the top three holdings with asset allocation of 8.64%, 8.46% and 8.07%, respectively. The fund charges a fee of 18 basis points.
Time for an Energy Sector ETF?
While the growth momentum is likely to sustain in the financial sector in 2013, the energy sector also appears to be well poised for 2013. When 2012 turned out to be the worst hit for energy-based ETFs due to a sluggish oil market, a rebound in energy prices in the second half gave some life to energy ETFs.
Moreover the recovery continued into 2013 with the sector posting huge gains to date. This may be due to mounting oil prices. A remarkable rise in oil production in the U.S. once again lured the global energy firms to the U.S. market. And it appears that the current boom in oil production should continue which should further strengthen energy ETFs going forward.
So a sector with strong fundamentals and cheaper valuations make an ideal area for investment this year. In this context, XLE is one of the more popular ways to tap the energy sector.
Given the current boom in oil prices and the bullish trend in oil production in the U.S., this ETF represents an effective way to capitalize on this strength as oil companies play a substantial role in the performance of the fund (5 Sector ETFs Surging to Start 2013).
Oil Gas & Consumables Fuels companies form 79.13% of the ETF portfolio while the rest goes to energy equipment & services. The high level of concentration in the oil sector companies has been a boon for the fund at this point of time.
The fund is home to 45 stocks in which it invests an asset base of $7.6 billion. The fund appears to be highly concentrated as it is 60.9% dependent on the top ten holdings for its performance. In fact, two oil giants Exxon and Chevron take away nearly 32% of the asset base. The fund charges a fee of 18 basis points annually.