Sector selection has been a big topic lately, as the market diverges, with sectors such as financials and homebuilders way down, while other sectors soar.
Both materials and energy have been the poster children for success through both the bull market that ended last fall and the most recent bear phase, as demand and prices for oil and commodities have been going up, and may go higher regardless of the fundamental reality.
Materials Sector SPDR
might be a way to benefit from the boom. Based on average volume of 10.9 million shares, the Street seems to agree and why not, over the last two years XLB is up 20% while the S&P 500 has been flat.
Unfortunately XLB, while it has been a good way to add performance versus a broad index like the
, has not really been a great way to capture the materials sector.
What has been behind the move in materials? Increased global demand for natural resources but unfortunately XLB is far heavier in chemical companies like
than purer resource companies.
Chemical companies are often consumers of natural resources so as the price of oil and other commodities have risen this has caused input prices to rise. Obviously a higher cost of doing business creates a drag on operating results.
The better performance during the commodity renaissance has come from, mostly foreign, mining stocks or thought of another way the companies that benefit from those higher input costs. This is where the
iShares S&P Global Materials Sector Index Fund
comes in. XLB is domestic stocks only and as mentioned mostly from chemical sub-sector. MXI only allocates 20.34% to the US and the vast majority of stocks are from the mining group.
BHP Billiton is the largest stock in the fund at about 10% (the sum of the UK and Australian listings). Also figuring prominently in the mix is
and even a couple of the ag plays, like
Potash Corp. of Saskatchewan
have grown into prominence in the fund.
Other large country weights besides the U.S. are the U.K. 14.93%, Australia 9.81% and Canada 9.58%.
This article is not about MXI, XLB or materials in general, it is about the need to look under the hood when trying to figure out what product offers the best way into a sector and the realization that the best way today may not be the best way in a few months.
Sticking with the materials sector, if input costs for chemical companies go down then XLB, or for that matter
iShares DJ Basic Materials Index Fund
, would look more attractive on a relative basis, and should be expected to outperform MXI in a world where prices for natural resources were declining.
In selecting a particular product as a proxy for a sector, it is important to know the current trends moving that sector and to follow any changes that occur.
One example of the importance of staying current would be the industrial sector:
weighs prominently in any of the cap-weighted industrial ETFs. GE has done poorly for years and has dropped 35% since last fall.
The simple act of seeking an industrial fund that either did not own GE or did not own a lot of it has been an excellent way to add value within the sector for the last couple of years.
Industrial Sector SPDR
allocates 16% to GE while the
PowerShares Water Portfolio
only 3%. This has been a big difference maker, over the last two and half years PHO is up 30% and XLI is up mid-single digits.
Just as PHO has done better for its much smaller weight to GE, it will be just as sure that when GE finally does provide leadership again, XLI will outperform PHO.
Sector selection is important, but how a sector is accessed once selected is just as important.
At the time of publication, Nusbaum was long MXI, RIO, AAUK, PHO, MON on behalf of himself and/or clients, although positions may change at any time.
Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback;
to send him an email.