What Sector ETFs Are Saying

A simplistic view would be to say the Utilities SPDR ETF XLU and the Energy Select Sector SPDR (ETF) XLE are impressing this year. So is the Materials Select Sector SDPR XLB. Beyond that, there is not a lot to brag about among the major sector exchange-traded funds.

The Sector ETF Story

Of course, there is more to the sector ETF story. Amid heightened market volatility, investors have largely favored lower beta sectors such as utilities and consumer staples while the Federal Reserve's refusal to raise interest rates to this point in the year was previously a drag on the financial services, the second-largest sector weight in the S&P 500.

More recently, once lagging financial services stocks and exchange-traded funds have recently sprung to life amid speculation the Federal Reserve is nearing its first interest rate increase of 2016, perhaps as soon as next month.

Related Link: Add Some Pep To Utilities Allocations With This ETF

Pay Attention To Shifts

There are important shifts among sector ETFs currently at work investors should take note of. Investors are starting to show a preference for momentum names.

“Take, for example, the consumer discretionary sector. As the chart above shows, it is trading very close to its 10-year high. But consumer discretionary is one of only two sectors, the other being health care, that reported positive earnings growth for the first quarter. Both sectors are also projected to post positive earnings growth for the full-year,” said State Street Vice President David Mazza in a recent note.

Conversely, energy and financial services are the only sectors trading below their 10-year average valuations. In the case of energy, that does not necessarily mean the sector is inexpensive because contracting earnings are a main reason why valuations in the group are declining. Adding a little something to the case for financials is that the sector is expected to post positive EPS growth this year.

Utilities, as has been widely, are richly valued relative an array of long-term averages, but with interest rates still low, investors continue embracing the sector.

“Investors appear willing to pay up for sectors that have performed well, but they are not willing to do so for sectors like financials and energy, where there is a great deal of uncertainty around their future earnings stream. This might remain the case until investors get more clarity on future interest rates hikes and the outlook for the US economy from the Fed,” added Mazza.