Winners & Losers In Post-Election Sector Rotation

November 23, 2016

By most accounts, 2017 promises to be a year of change following an election that delivered a surprising Republican sweep. Markets and investors have been reacting to those results, and adjusting portfolios as they look ahead. David Mazza, head of ETF and mutual fund research at State Street Global Advisors, breaks down some of the ongoing sector shifts, and what it all means going into 2017. Let’s talk about some of the sector shifts we’ve seen since the election. Perhaps the biggest jump has been in financials. The Financial Select Sector SPDR Fund (XLF) saw record inflows last week. Is that just short-lived market reaction, or is the financial sector poised to do well going forward?
David Mazza:
There are some trends that had been emerging prior to the election, and the sweep of the Republican Party acted as an accelerant to certain trends. One in particular is in financials. We've seen record inflows over the past two weeks.

There are still a lot of questions about a Trump administration. But the potential for less onerous regulations—which had been impacting financials—coupled with an improving economy over the past couple of quarters, boosting earnings in certain financial companies, and the fact that we’re looking at a 90% chance the Federal Reserve will raise rates in December … all of those things are adding to investor interest in what had been a significantly undervalued sector across the market. They’ve all helped propel it forward, and potentially could keep up into next year. What about technology and the action we’ve seen in recent days?
There are questions about what a Trump administration would do compared to a Democratic administration when it comes to allowing the tech sector to propel. We’ve seen some profit-taking, as it's been an area that’s done well this year.

As investors look to rotate into areas that have done poorly, they've been using their tech-related gains as a funding mechanism, really, more than it being a reflection of the potential for technology going forward. What sectors do you see winning and losing in a sector rotation going into the new year and a new president?

Mazza: The first thing we need to get past prior to the inauguration is the Federal Reserve meeting in December. Our expectation is that we may continue to see the trends that have been put in place—rotation out of the bond proxies in the market, out of utilities, staples, real estate, and into the more cyclical sectors, like financials, health care, energy, materials and the like.

We expect the moves in the interest rate market and the dollar to impact equity sectors heading into the Federal Reserve meeting. But depending on the statement by the Federal Reserve and what they may allude to for 2017, you could end up with a bit of a pause across the markets broadly heading into the new year. We’ve seen impressive performance in small-caps recently. Is that just typical performance in a market rally, or is there something else driving this pickup in demand and in performance?

Mazza: One of the big drivers of small-cap stocks on a relative basis to large-cap stocks is the dollar. They tend to be more domestically oriented than their larger, more multinational peers. As the dollar hit 13-year highs, it's helped sentiment in the small-cap space.

Couple that with the fact that investors are now more comfortable looking at undervalued areas—not just your steady-Eddie growers in the market as some uncertainty has been lifted—you may see small-caps continue to do well on a relative basis to large-caps.


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