A Sector ETF For Risk Takers

The materials sector is the smallest sector in the S&P 500 at a weight of just 2.73 percent. As such, the Materials Select Sector SPDR XLB doesn't garner attention on par with the sector SPDR exchange traded funds tracking the technology, health care or financial services sectors, just to name a few.

What Happened

Despite the sector's diminutive nature and XLB's tendency to toil in anonymity relative to other sector ETFs, the fund is up 11.54 percent year to date and may present risk-tolerant investors with the opportunity for more upside.

In a recent research note, AltaVista Research tagged XLB, the largest materials ETF by assets with a “Speculative” rating. The research firm typically applies ratings of “Neutral,” “Overweight” and “Underweight” to the sector SPDR ETFs, but that does not mean the rating on XLB is bad.

AltaVista's “Speculative” rating is reserved for ETFs that are “deeply undervalued but risky.”

Why It's Important

Risky could apply to XLB and the materials sector over the near term. This is a cyclical sector with export exposure, meaning it can be vulnerable to erosion in the business cycle and another flareup in trade tensions.

“A rating of SPECULATIVE is assigned to ETFs with ALTAR Scores in the top quintile (the top 20%) of their category, indicating exceptional appreciation potential,” said AltaVista. “However, often these are narrowly-focused funds or in industries with structural issues, which may also make them very risky.”

The $3.37 billion XLB holds 27 stocks with a weighted average market value of $40 billion. Linde Plc LIN and Dow Inc. DOW are XLB's marquee holdings.

What's Next

The materials sector and ETFs such as XLB are predominantly driven by chemicals manufacturers, which have exposure to the domestic energy cycle.

“Abundant domestic energy is spurring an investment boom among chemical firms which comprise ~70% of the sector,” said AltaVista. “Our rating may overstate the sector's attractiveness due to distortions in financial results and estimates resulting from merger and spin-off activity, though discount valuation multiples versus the market also suggest value. However, earnings forecasts have deteriorated rapidly in recent months as has sell-side sentiment on the sector.”

XLB is the only one of the 11 sector SPDR ETFs rated by AltaVista that has the “Speculative” rating.

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