Yusko On Seasonal Sector Investing

Some sectors are more susceptible than others to the optimism every new year seems to bring.

Reviewed by: Drew Voros
Edited by: Drew Voros

[This interview originally appeared in our August issue of ETF Report.]

Mark Yusko is the chief executive officer and chief investment officer of Morgan Creek Capital Management LLC, which is the subadvisor for the AdvisorShares Morgan Creek Global Tactical ETF (GTAA | 62). From 1998 to 2004, he led the endowment office at the University of North Carolina at Chapel Hill. He is a frequent speaker at conferences, including ETF.com's Inside ETFs and Global Macro, as well a regular commentator on Bloomberg TV and CNBC.

How do you approach sector investing?
Inside the U.S., sectors matter, and we actively use the nine sector ETFs to overweight or underweight our view of the U.S.

For the last year or so, we've believed the economy was going to be weaker than people expected. In a weakening economy, you want to be overweight health care, consumer staples, utilities and technology, and you want to be underweight things like materials, industrials and consumer discretionary.

That worked really well for us in 2014, and was working pretty well for us through January of this year. But then on Feb. 1, like a light switch, everything from the last year changed. Utilities, for instance, have gotten smashed.

Why is that?
Two reasons. One is that hope springs eternal. Every first quarter, everybody believes economic growth is going to be better than it actually turns out to be in the U.S., and that interest rates always rise. Personally, I think interest rates always rise earlier in the year because the mortgage industry wants them to rise so they can lock in higher rates. People normally move between February and May, so you see rates usually peak and inflation expectations usually peak in April/May.

The early-year optimism also could be linked to the whole stock market saying, "Sell in May and go away." Housing and stocks are different, but the bottom line for both is that hope springs eternal. People think growth is going to be better, and thus interest rates are just going to rise. But since Feb. 1, utilities have been getting killed, and so has the iShares 20+ Year Treasury Bond (TLT | A-85), giving back all its annual gain. Anything related to yield did poorly after then.

I'm still in the camp of lower rates for longer. I don't believe rates are going to go zooming up. Growth is going to be a big surprise to the positive, but the markets in the short term can be very, very volatile.

Right now the bond bears have control of the bond market. Interestingly, even though the equity market is repeatedly hitting "all-time highs," it's only been hitting those highs by one or two points. We've basically been flat for the better part of six months.

That's not good, bad or indifferent. It just tells me to be overweight health care in funds like the Health Care Select SPDR (XLV | A-95) because there's a lot of innovation going on there. It's the same thing in technology. We like being overweight in technology, such as in the Technology Select SPDR (XLK | A-90).

We've gotten rid of our exposure to the Consumer Staples Select SPDR (XLP | A-92) and the Utilities Select SPDR (XLU | A-89) because even though we think the economy is slowing, no one else seems to believe that. We don't want to get in the way of that train.

So you don't always hold all the sectors.
Correct. We try to own four, sometimes we'll go short a couple, and then we probably are neutral on the middle three.

Do you think sector investing is losing its attraction or being overshadowed by the growth of smart beta?
Smart beta is one of the most brilliant marketing strategies, but I actually don't think it's a very good strategy. To me, it's like risk parity, and it's dangerous, but it's great marketing. For the average person, risk parity has been a nightmare.

Smart beta is just a terrible strategy, but it's better than pure indexing. I think of pure indexing as cap-weighted; that puts you in the wrong thing at the wrong time. You have maximum exposure to the wrong sector at precisely the wrong time—like technology in 2000 or real estate and financials in 2007—but I don't know that smart beta does enough.

People are taking their eye off the ball a little bit. Beta isn't smart. It's the market. Alpha is smart. But again, it's good marketing.

What other sectors or areas do you like?
It's not a sector per se, but I think a surprise would be if commodities stabilize and actually have a good second half. A lot of people don't believe that could happen, but I think that could be interesting.

The problem with commodities is that there are different ones with different fundamentals.

For example, we think precious metals are really more of a currency right now and have actually been strong relative to other currencies. Then you've got base metals, which could reverse here if growth starts to pick up outside the U.S. The U.S. growth isn't very metals heavy, but China's is. And if they really get this property turn right, you could see some interesting new demand for copper and zinc, and those types of things.

And then there's agriculture. I hate to invest in anything that is all about weather, but if El Nino really is what they say it's going to be this year, then I think ags—which are plumbing multiyear lows—could be interesting. There are some very cool ETFs that are worth looking at here.

Such as?
The iPath Bloomberg Coffee ETN (JO|C-92) for starters, and the PowerShares DB Agriculture ETF (DBA | B-38). The Teucrium Corn (CORN | D-84), Teucrium Wheat (WEAT | F) and Teucrium Soybeans (SOYB | F-44) ETFs are also at least worth looking at.

I'm not saying people should rush in and buy them, but they're worth a peek, because they're down a lot and weather tends not to repeat. We had record harvests last year, and usually that doesn't happen two years in a row. But, again, I hate tying my fortunes to weather because it's unpredictable.

Drew Voros has nearly 30 years' experience in financial journalism. He was a longtime business editor for the Oakland Tribune and sister papers of the Bay Area News Group, and finance writer for the Hollywood trade publication Variety. Voros' past roles have also included editor-in-chief at etf.com and ETF Report.