Best & Worst Sector ETFs: 2Q 2020

Much has been written about the resiliency of the U.S. stock market this year. Even with the latest pullback in the market, the S&P 500 is up 32% off its March lows and down a “mere” 12.8% from its February all-time high.

Considering that the economy is on pace to contract at its fastest clip in the postwar era this quarter, and unemployment is on track to challenge its Great Depression peak, you might have expected that stocks would be down much more, 

But they’re not.

There are many explanations for this phenomenon; one of them is that the technology heavyweights that make up a large part of the markets are holding up extremely well—even thriving—in this environment.

Rare Gains
It comes as no surprise then that technology happens to be the best-performing sector of the year, with a 5% gain in the year-to-date period through May 18, as measured by the Technology Select Sector SPDR Fund (XLK). It’s the only one of the 11 sectors under the Global Industry Classification Standard (GICS) to be in the green in that time frame.

XLK’s top holdings include Microsoft and Apple, which together make up a whopping 42.5% of the ETF. Both stocks have recovered rapidly from the March lows and sit not far from their record highs thanks to the resiliency of their growth and profits, along with their strong, cash-rich balance sheets.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

The other 57.5% of XLK’s portfolio has done well also, with many software and hardware companies benefiting from the digital transformation and work-from-home trends that are now in full force.

Vaccine Race Fuels Health Care
The only other sector to come even close to tech’s outperformance this year is health care. The Health Care Select Sector SPDR Fund (XLV) is hovering just below the flat line for the year, down about 0.1%. It’s not hard to understand the outperformance; health care companies are at the center of the race to find a COVID-19 vaccine and treatments.

Two of XLV’s top holdings, Johnson & Johnson and Pfizer, are among the firms that are furthest along in the vaccine development timeline. Meanwhile, another top-five holding, Abbot Labs, has been a leader in coronavirus testing.

And it’s not just drug companies that are doing well. Health insurers like UnitedHealth have been buoyed amid a drop in demand for non-coronavirus-related procedures, reducing the amount of cash the companies need to shell out. The firms’ political fortunes improved as well once Joe Biden became the presumptive Democratic nominee, beating out Bernie Sanders, a champion of Medicare-for-all.

Former Tech Stocks Power ‘XLC’
Outside of tech and health care, the three other sectors that have performed better than the S&P 500 so far in 2020 are communication services, consumer discretionary and consumer staples.

The Communication Services Select Sector SPDR Fund (XLC), with its relatively modest 2.2% loss, is home to former tech heavyweights like Facebook and Alphabet. Under the GICS, these two companies were moved from tech to the communication services sector in 2018. However, they are still widely considered tech companies by many investors. (Read: Changes Ahead For 24 Sector ETFs)

The two stocks combine to make up nearly 44% of XLC’s portfolio, which given their strength this year, has benefited the fund. Activision Blizzard, a video game developer, and Netflix make up 10% of XLC’s holdings, and both have been on fire as people are spending more time indoors.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

Sector ETF Performance & Flows

Data measures the year-to-date period through May 18

The Amazon Effect
It may be surprising to see the Consumer Discretionary Select Sector SPDR Fund (XLY) down only 4% this year. The ETF’s portfolio is chock-full of retailer, hotel and entertainment companies, and apparel companies that have been crushed this year, and yet somehow, it’s outpacing the 6.9% loss for the Consumer Staples Select Sector SPDR Fund (XLP), an ETF that is typically considered the safer fund.

Many of the stocks that XLY holds are doing extremely poorly in this economic environment, but not all of them. E-commerce juggernaut Amazon has seen an explosion in demand for the products on its platform, helping send its stock to an all-time high.

Like Facebook and Alphabet, Amazon is another name that is commonly considered a tech company, especially as its cloud computing services make up an increasing share of its profits and operations. Nevertheless, the firm does have characteristics of a consumer discretionary firm, hence its inclusion in XLY.

With its $1.2 trillion market cap, Amazon accounts for one-quarter of XLY’s portfolio, and that concentration has immensely helped the fund’s performance.

But it’s not just Amazon. Companies such as Home Depot, McDonald’s, Target and Dollar General have been relatively insulated from the economic devastation thus far, and together they make up a good chunk of XLY. In an environment where the strong have gotten stronger, XLY’s market cap weighting has been an advantage.

(Use our stock finder tool to find an ETF’s allocation to a certain stock.)

In The Dumps
Five sectors have managed to outperform the broader market this year; the others are all down double-digit percentages. The worst three are energy, financials and industrials.

News feeds have been flooded with stories about the stunning demise of crude oil prices this year. WTI, the most popular U.S. benchmark for crude, famously dove into negative territory last month. It’s not a shock then to see energy at the bottom of the barrel in terms of sector performance. The Energy Select Sector SPDR Fund (XLE) last traded with a year-to-date loss of 33.6%—horrible, but better than the 60% loss the ETF had at its lows.

The Financial Select Sector SPDR Fund (XLF) follows closely behind energy, with a 27.5% decline. While banks are considered to be in much better shape currently than they were during the financial crisis 12 years ago, loan losses will surely rise as individuals and businesses find it increasingly difficult to pay back what they borrowed.

There is also concern about negative interest rates. Thus far, the Fed has rejected the idea of pushing its benchmark fed funds rate below zero, but if that were to materialize, it could pressure banks’ deposits, as some customers balk at paying for the right to store their money at financial institutions. Rising competition from financial technology companies like online-only challenger banks and peer-to-peer application providers are also weighing on the sector.

Finally, the Industrial Select Sector SPDR Fund (XLI) has been weighed down by the near-complete shutdown of the aerospace industry. Stocks in that group make up 21.6% of the ETF.

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2