As the second quarter begins, market leadership is shifting. As the last few weeks of the first quarter of 2021 were winding down, it became apparent that the best ETFs of 2020 were losing their shine and that a new set of ETFs would be taking the torch of market leadership in Q2.
By mid-March, investors got spooked by the Fed’s apparent open door policy to inflation. Going into Q2 and beyond, the potential for rising interest rates and higher inflation is causing a rotation out of riskier overpriced assets and into a small handful of sectors that can survive this new economic environment.
Now is the time to balance the crosscurrents of cautious investing coming out of Q1 with the potential to capture more upside for the remainder of 2021. Of course, investors are also wise to consider areas of the market that can perform relatively well in an inflationary environment.
In no particular order, here are seven ETFs that have outperformance potential for Q2 and the remainder for 2021:
- Vanguard Value ETF (NYSEARCA:VTV)
- Utilities Select Sector SPDR (NYSEARCA:XLU)
- Consumer Staples Select Sector SPDR (NYSEARCA:XLP)
- Vanguard Materials ETF (NYSEARCA:VAW)
- Industrial Select Sector SPDR (NYSEARCA:XLI)
- Vanguard Financials ETF (NYSEARCA:VFH)
- Vanguard Real Estate ETF (NYSEARCA:VNQ)
These ETFs have recently underperformed the broader market but had a strong March to end Q1. That suggests momentum going into Q2.
Best ETFs With Momentum Going Into Q2: Vanguard Value ETF (VTV)
Expenses: 0.04%, or $4 for every $10,000 invested
March Gain: 6.66%
Q1 Performance: 11.11%
If you’re looking for a diversified ETF with upside potential in Q2 without the higher risk of growth stocks, Vanguard Value ETF (NYSEARCA:VTV) could be a smart holding.
There’s no question that large-cap growth stocks were a smart area of the market to hold in 2020 and Q1 2021. But large-cap value could be a smarter place to be in Q2 and beyond.
With a heavy concentration of financial stocks (20% of the portfolio) and a low allocation to technology (5%), plus exposure to every other sector of the economy, shareholders of VTV get broad-based exposure to the U.S. economy with moderate risk.
Utilities Select Sector SPDR (XLU)
March Gain: 10.55%
Q1 Performance: 2.90%
Coming off of a weak 2020 and poor beginning to 2021, the Utilities Select Sector SPDR ETF (NYSEARCA:XLU) was among the best sector funds in the final month of Q1.
A shift to interest in defensive stocks, plus a friendly political environment for renewable energy sources, makes utilities stocks more attractive now than they’ve been in recent quarters.
The XLU portfolio consists of 28 U.S. companies in utilities industries, such as electric utilities, gas utilities, independent power, and renewable energy. As such, XLU shareholders get top utility holdings like NextEra Energy (NYSE:NEE), Duke Energy (NYSE:DUK) and Southern Company (NYSE:SO).
Consumer Staples Select Sector SPDR (XLP)
March Gain: 8.49%
Q1 Performance: 1.82%
As investors began to worry about downside pressure on highly-priced growth stocks in Q1, they began rotating into defensive sector funds like Consumer Staples Select Sector SPDR (NYSEARCA:XLP).
Like other defensive sector funds, XLP has taken a back seat the hotter areas of technology and consumer discretionary stocks. But if the 8.49% gain in March is telling investors something, it may be that XLP could be a smart place to be in the coming months and the greater part of 2021.
The attraction and defensive nature of consumer staples is that companies in the sector sell products (such as food, beverages, and household products) that remain in demand, no matter what the economy is doing. Examples include XLP top holdings Proctor & Gamble (NYSE:PG), Coca-Cola (NYSE:KO) and PepsiCo (NASDAQ:PEP).
Vanguard Materials ETF (VAW)
March Gain: 8.35%
Q1 Performance: 10.53%
The materials sector generally responds positively to growing global economies, which makes Vanguard Materials ETF (NYSE:VAW) a potential winner for Q2 2021 and beyond.
When thinking of the materials sector, think of companies that produce raw materials, such as cement, bricks, glass, chemicals, metals and lumber, which are used for building, manufacturing and construction.
The VAW portfolio provides focused exposure to 115 stocks, across more than a dozen materials industries, including specialty chemicals, industrial gases, gold and steel, all of which can benefit from growing global economies.
Industrial Select Sector SPDR (XLI)
March Gain: 8.99%
Q1 Performance: 11.52%
Judging from strong performance in March, the Industrial Select Sector SPDR Fund (NYSEARCA:XLI) could be a good fund to hold in the coming quarters.
In addition to the materials sector, the industrials sector is one that stands to benefit from a post-pandemic global expansion, as well as a potential infrastructure boom in the U.S.
Industrial sector companies are involved in the industries of aerospace and defense, transportation infrastructure, machinery and electrical equipment. The XLI portfolio provides concentrated exposure to 74 industrial stocks like Honeywell International (NYSE:HON), Union Pacific Corporation (NYSE:UNP) and Boeing (NYSE:BA).
Vanguard Financials ETF (VFH)
March Gain: 5.66%
Q1 Performance: 16.51
In a rising interest rate environment, financial sector funds like Vanguard Financials ETF (NYSEARCA:VFH) have potential to outperform the broader market indices.
As interest rates rise, financial companies like banks and lenders, can widen their profit margins as the spread between their borrowing rate and the rates they offer their customers gets wider. VFH has plenty of stocks like this, including top holdings JPM, BRK.B and Bank of America (NYSE:BAC).
Since inflation often accompanies a rising rate environment, investors are wise to look for sectors that can raise pricing potential alongside rates and higher costs. The financial sector is just such an area.
Vanguard Real Estate ETF (VNQ)
March Gain: 5.15%
Q1 Performance: 8.79%
With home prices climbing, rental properties stand to gain, which makes Vanguard Real Estate ETF (NYSEARCA:VNQ) a potential standout in Q2 and beyond.
VNQ offers focused exposure to U.S. real estate investment trusts (REITs) covering real estate industries like hotel and resorts, health care properties, residential and retail.
The VNQ portfolio holds 174 U.S. REITs, including companies that purchase office buildings, hotels, and other real property. Top holdings include American Tower (NYSE:AMT), Prologis (NYSE:PLD) and Crown Castle International (NYSE:CCI).
Here’s the disclosure for this one: On the date of publication, Kent Thune did not personally hold a position in any of the aforementioned securities, although he holds XLU and XLP in some client accounts. Under no circumstances does this information represent a recommendation to buy or sell securities.