Jilted Lovers: Investors Are Souring On Defensive Sector ETFs

Part of the reason some investors are not trusting the rally in equities this year is the perception that defensive, low beta sectors are leading broader benchmarks higher.

And part of the reason that defensive groups, such as consumer staples and utilities are soaring is that these sectors are interest rate-sensitive, meaning the Federal Reserve's refusal to raise interest rates this year is giving investors good reason to embrace higher-yielding, lower beta sectors.

Good Things Don't Always Last

Just look at the Consumer Staples Select Sect. SPDR (ETF) XLP and the Utilities SPDR (ETF) XLU. The largest consumer staples and utilities ETFs are up 9.3 percent and 17.8 percent, respectively, year-to-date. Either XLP or XLU on their own or 50/50 split of the two would be offering investors returns well in excess of the 7.9 percent generated by the S&P 500 year-to-date.

However, many good things come to an end and while it is still in the speculative stages, there are signs investors are tiring of the low beta love affair. That could also mean equity markets are pricing in an interest rate hike the Treasury market is not yet acknowledging.

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XLP's “short interest as a percentage of shares outstanding — now at 9.6 percent — is the highest since June 2015, data compiled by IHS Markit (Markit Ltd INFO) show, and has nearly tripled since mid-June,” according to Bloomberg.

Holdings

XLP's top 10 holdings include Dow components Procter & Gamble CoPG, The Coca-Cola Co KO and Wal-Mart Stores, Inc. WMT. Those stocks combine for nearly 27 percent of the ETF's weight. Procter & Gamble and Wal-Mart are two of the 14 Dow members up at least 10 percent year-to-date.

Year-to-date, investors have been responsive to XLU and XLP, adding $1.18 billion and nearly $286 million, respectively, to those ETFs. But in another sign that enthusiasm for these funds is waning, investors have been scurrying for the exits in the current quarter. Since the start of the third quarter, over $630 million has been pulled from XLP while XLU has lost $742.6 million in assets.

Underscoring the point that investors are either concerned about a rate hike, want to embrace riskier or fare or both, the iShares Barclays 20+ Yr Treas.Bond (ETF)TLT, one of this year's best-performing fixed income ETFs, has bled more than $773 million since the start of the current quarter.