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Will Rotation to Cyclical ETFs Continue in September?

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Last month was one of the best for the U.S. stock market as the Dow Jones Industrial Average and the S&P 500 capped off their best August returns since the mid-1980s (read: ETFs to Ride the Market's Best August Rally in More Than 30 Years).

The historic rally came on the back of prospects of a prolonged low-interest-rate environment, progress in a treatment or vaccine for COVID-19, and encouraging rounds of economic data, which point to higher consumer sentiment, confidence and spending.

Although technology was at the forefront of the August rally, cyclical sectors like consumer discretionary and also took charge. This is because the cyclical stocks are tied to economic activities and when growth improves, these sectors perform well. The economy is gradually returning to the pre-pandemic level, sparking investor optimism and providing enough impetus to economic-sensitive sectors (read: Top ETF Stories of the Best August in 34 Years).

Given this, several ETFs that belong to the cyclical sectors have easily crushed the S&P 500’s 7% return clocked in August.

Cyclical ETFs That Outperformed

First Trust Nasdaq Transportation ETF (FTXR - Free Report) has been the biggest beneficiaries of the cyclical sector rotation, having risen about 17.1% in the past month. This fund offers exposure to the most-liquid U.S. transportation securities based on volatility, value and growth.

Direxion MSCI Cyclicals Over Defensives ETF (RWCD - Free Report) has gained about 14% past month. It tracks the MSCI USA Cyclical Sectors – USA Defensive Sectors 150/50 Return Spread Index, which measures the performance of a portfolio that has 150% long exposure to the MSCI USA Cyclical Sectors Index and 50% short exposure to the MSCI USA Defensive Sectors Index.

First Trust NASDAQ Global Auto ETF (CARZ - Free Report) , Invesco DWA Consumer Cyclicals Momentum ETF (PEZ - Free Report) and U.S. Global Jets ETF (JETS - Free Report) have gained nearly 13% past month. CARZ offers a pure-play global exposure to auto stocks by while JETS provides exposure to the global airline industry, including airline operators and manufacturers from all over the world. PEZ targets the broad consumer discretionary sector offering exposure to stocks having positive relative strength (momentum) characteristics (read: August Clocks Monster Gains: 5 ETF Areas Up At Least 20%).

Will The Trend Continue in September?

After the best month in decades for stocks, investors are optimistic that the rally will continue given the support from the Federal Reserve, rising optimism for a COVID-19 vaccine, and a new stimulus package. The combination will continue to strengthen the cyclical sectors. In fact, U.S. stocks were off to solid start to the month in the first trading day with the S&P 500 and Nasdaq hitting new highs.

However, September is historically the worst month for the stock market. Per the LPL Financial data, the S&P 500 has fallen about 1% on average in September since 1950. It also revealed that the S&P 500 has shed 0.2% on average in the election year. This election year could be worse given that the COVID-19 pandemic continues to rage globally. Since World War II, the S&P 500 has seen an average decline of 0.5%, according to CFRA (read: Key ETF Areas to Track as Biden Victory Looks Quite Likely).

The declines are due to a seasonal phenomenon as investors are more prone to selling than buying when they return from their summer vacations, trading volume after Labor Day is mostly bearish, many mutual funds have fiscal years ending Sep 30, window-dressing is rampant, and investors generally sell stocks to pay tuition bills for their kids’ private schools and colleges.

Although election uncertainty and the historically weak month continue to dent sentiments, risk-tolerant long-term investors could continue to invest in cyclical stocks should they have the patience for extreme volatility given the twin tailwind of a potential vaccine and massive stimulus.

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