Sector Funds: Best, Worst, and Mid-Year 2010 Stock Market Outlook (SPY, XLF, XLE, XLP, EEM)

The past 45 days have brought about an abrupt change in the markets. After being in a phase of never-wanting-to-go-down from February through April, markets around the globe have turned south in a hurry. Steep losses in equity prices since late April have put most of the markets around the world in the red for the year.

In the U. S., the SPDR S&P 500 ETF (NYSE:SPY) that tracks the popular S&P 500 index ($SPX) is down 3.8%. Overseas markets have lost more. The iShares MSCI EAFE ETF (NYSE:EFA) and iShares MSCI Emerging Markets Index ETF (NYSE:EEM) that serve as proxies for developed and emerging markets, respectively are down 15.2% and 10.4%, respectively.

Best Sector Funds

From a sector perspective, consumer discretionary and industrials have fared the best year-to-date. Consumer Discretionary Select Sector SPDR ETF (NYSE:XLY) and Industrial Select Sector SPDR ETF (NYSE:XLI) are up 6.1%, and 2.7%, respectively. The Fidelity Select universe has performed similarly with Fidelity Select Consumer Discretionary (FSCPX) and Fidelity Select Industrials (FCYIX) advancing 7.1% and 2.3%, respectively.

Strong year-over-year earnings improvement from recessionary levels helped consumer discretionary shares to rebound from low valuation levels at the start of the period. Stronger demand for industrial goods from emerging markets and falling energy costs contributed to relative outperformance of the industrial sector.

Sector Funds: Best, Worst, and Mid-Year 2010 Stock Market Outlook
Performance of sector funds: Year-to-date, the Consumer Discretionary Select Sector SPDR ETF (NYSE:XLY) has led the way while Materials Select Sector SPDR ETF (NYSE:XLB) has lagged.

Worst Sector Funds

Commodity-related materials and energy sectors have fared the worst year-to-date. Materials Select Sector SPDR ETF (NYSE:XLB) and Energy Select Sector SPDR ETF (NYSE:XLE) are down 11.6%, and 9.3%, respectively. Fidelity Select Energy (FSENX) is down 12.8% while Fidelity Select Materials (FSDPX) is down 8.7%.

Strong demand for commodities helped materials and energy stocks gain early in the year. The advance wore off when the U. S. dollar gained ground and commodity prices started to falter. While BP’s (BP) Gulf of Mexico disaster and Australia’s plans for increasing mining taxes added to these sectors’ woes, worsening fiscal condition of many European economies is the more important reason for weakness in materials and energy shares.

Mid-Year 2010 Stock Market and Sector Fund Outlook

As the midpoint of year 2010 approaches, a few themes dominate investor attention. They include:

  • Strained fiscal situation in Europe and the possibility of a contagion
  • Rising inflation and slowing growth in emerging markets
  • Flat or worsening employment situation in the U. S.

Against this backdrop, will consumer discretionary continue as a momentum play to be the best performer in the second half? Or is it turn for commodities as a value play to take charge?

Momentum plays tend to work well in the short-term and value plays in the long-term. The turning point in leadership change often comes when the crowd piles to overvalue sectors in favor. Likewise fear or neglect leads to undervaluation that is eventually corrected. More often, sectors with adequate momentum and reasonable valuation have a higher probability of becoming best performers. See: Sector Rotation – Increase Your Sector Selection Success by 75%

With Europe’s financial troubles likely far from over and persistently high levels of unemployment acting as a headwind for consumer spending, neither commodities nor consumer discretionary investments may prove to be the best performer in the remainder of the year.

Listed in alphabetical order with no probabilistic significance attached, the odds of consumer staples, financials, or industrials turning out to be second half’s best performer appear higher. Fidelity Select Consumer Staples (FDFAX), Consumer Staples Select Sector SPDR ETF (NYSE:XLP), Fidelity Select Financial Services (FIDSX), Financial Select Sector SPDR ETF (NYSE:XLF), Fidelity Select Industrials, and Industrial Select Sector SPDR ETF are among the mutual funds and ETFs available for these sectors.

As always, selected industries or groups within winning sectors will likely provide investors bigger gains. We will be directing our efforts at identifying such leaders when we recommend new investments for Premium Service readers on June 30.

Written By Dr. Sam Subramanian From AlphaProfit

Dr. Sam Subramanian is Managing Principal and Chief Investment Officer of AlphaProfit Investments, LLC. He edits and publishes the AlphaProfit Sector Investors’ Newsletter™. The AlphaProfit Sector Investors’ Newsletter has received the distinction of getting ranked #1 by Hulbert Financial Digest several times. He also edits the AlphaProfit’s popular investing blog and e-letter MoneyMatters.

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