There isn’t much room for discussion regarding SPDRs in my house, other than my daughter screaming, “Dad, can you come and kill a spider?” How she spots these tiny little things across the room is a mystery to me.
But I digress.
Sector funds are a double-edged sword. In the early days of sector mutual funds, one had to proceed with caution because the concentration of a sector fund meant you were exposed to a lot of volatility. Moreover, you couldn’t jump in and out of mutual funds intra-day. Then the fund companies cracked down on making too many trades within a certain number of months.
SPDR funds made it a lot easier to reallocate instantly. I think SPDR funds can have a place in certain portfolios, but one must tread wisely and keep an eye on them. If you don’t have an expertise in certain sectors, or an understanding of how they interface with the overall economy, you may want to avoid SPDR funds.
Here are three SPDRs I suggest avoiding for now:
3 Sector SPDR Funds to Sell Now: Materials Select Sector SPDR Fund (XLB)
Click to Enlarge
The Materials Select Sector SPDR ETF (NYSEARCA:XLB) is not a place I want to be right now. The economy is really just sputtering along and the demand for materials is not what it could be.
We’re talking about chemicals, construction materials, containers, packaging, metals and mining, and paper and forest products.
Certainly the miners are struggling because commodity prices are down. The environmentalists control the national narrative right now, harming forest and paper products. The chemicals industry is under siege from everyone who hears the very word “chemical” and freaks out. And God forbid you even mention Monsanto Company (NYSE:MON).
The top 10 holdings make up 63% of the index — that’s way too much concentration. That’s also why we’re seeing underperformance in the SPDR fund.
3 Sector SPDR Funds to Sell Now: Industrial Select Sector SPDR Fund (XLI)
Click to Enlarge
A close cousin to this is the Industrials Select Sector SPDR Fund (NYSEARCA:XLI). For much of the same reasons I mentioned with the Materials SPDR, the Industrials SPDR is facing the same economic headwinds.
There is some offset here, in that you have some defense and aerospace, which are traditionally pretty resilient. Yet there are a host of other conglomerates in the SPDR that are struggling.
The top 10 holdings also account for 46% of the asset base, which isn’t as high as the XLB SPDR, but is still pretty high.
Since the SPDRs inception in 1998, the XLB SPDR has been the fourth-best performer out of nine total. Interestingly, it is always in the middle of the pack. That’s likely due to the cyclicality of the sector, and another reason I’m not keen on it.
I think you sell this particular SPDR here.
3 Sector SPDR Funds to Sell Now: Utilities Select SPDR Fund (XLU)
Click to Enlarge
I think other than those two, you are probably good to hold others, but if I had to suggest one other one to dump, I might suggest the Utilities Select Sector SPDR Fund (NYSEARCA:XLU).
I think there’s been a rush away from the low-to-no interest rates that bonds are paying, and income investors went into utilities and other yield stocks. Utilities are running close to all-time highs in their price-to-earnings ratios, and the XLU is just off its all-time high.
The 3.5% yield is attractive, but the risk of significant downside makes that seem paltry.
Utilities are themselves important elements in a diversified portfolio because they are, in many ways, recession-resistant. People need electricity and the regulated format that many of them take means a constant flow of cash to address debt, capital expenditures and dividend payments.
Still, I think there’s less risk and higher dividends in preferred stocks. That’s where I’d turn instead if you want yield.
Lawrence Meyers is the CEO of PDL Capital, a specialty lender focusing on consumer finance. He has 20 years’ experience in the stock market, and has written more than 1,200 articles on investing. He is the Manager of the forthcoming Liberty Portfolio. He can be reached at TheLibertyPortfolio@gmail.com. As of this writing, he held no positions in any of the aforementioned securities.
