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Time to Tap Cyclical Sector ETFs?

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Wall Street has rallied hard this year on vaccine distribution, a prolonged period of easy money policy and fiscal stimulus. Stronger-than-expected earnings are the major catalysts at present. The Q2 earnings picture has been robust, with aggregate total quarterly earnings on track to reach a new all-time record. The strength has been palpable on the revenue side (read: S&P 500 to Roar Higher: ETFs to Ride the Rally).

Data points too are suggesting the same. The U.S. economy added 943,000 jobs in July 2021, the maximum in eleven months and above market expectations of 870,000. The U.S. economy returned to the pre-pandemic level with GDP rising 6.5% annually in the second quarter.

Consumer confidence rose to a 17-month high in July. The Senate’s move of introducing the bipartisan infrastructure bill of $550 billion on Aug 1 in addition to the previously-approved funds of $450 billion for five years has brought some optimism among investors. Total spending may go up to $1.2 trillion if the plan is extended to eight years (read: ETFs to Win on Latest Infrastructure Bill Talks).

While such optimism has triggered rising rate risks and the associated risks for rising inflation, Chief Investment Officer of HSBC Wealth Management Xian Chan said that after a period of concern about consistently higher inflation, markets appear to have got immune to such threats, as quoted on CNBC.

Xian pointed out that while U.S. consumer price inflation remained high at an annual 5.4% in July, the 10-year U.S. Treasury yield has subdued.  It means stocks will rally as investors are ignoring inflation. Notably, if inflation rises, bond yields should rise too. But opposite is happening this year on COVID fears. HSBC forecasts that bond yields will fall as low as 1% by the end of the year.

This should favor consumer-oriented stocks, per the HSBC strategist. We expect some cyclical sectors will likely fare better. Notably, cyclical industries are sensitive to the business cycle. These industries generate higher volume of revenues in periods of broader economic expansion and vice versa.  

Against this backdrop, below we highlight a few sector ETFs that could gain ahead.

SPDR S&P Bank ETF (KBE - Free Report)

Banking stocks were extremely beaten down in the peak of the pandemic as fears of higher defaults at the household and corporate levels hit the space hard. Banking stocks offer value now. Banking stocks are highly cyclical as these are vulnerable to changes in economic conditions and policies. Moreover, taper talks are doing rounds. This would steepen the yield curve and favor bank stocks and ETFs.

Consumer Discretionary Select Sector SPDR ETF (XLY - Free Report)

If job data remains stable and rates remain low, consumers may splurge on activities. However, volatility should remain in place on COVID fear. The underlying Consumer Discretionary Select Sector Index of the fund seeks to provide an effective representation of the consumer discretionary sector of the S&P 500 Index.

Industrial Select Sector SPDR ETF (XLI - Free Report)

The sector has suffered massively amid the pandemic. With millions of Americans still unemployed, the creation of blue-collar jobs would be of high priority. The latest recruitment pattern in the sector also calls for optimism.

Vanguard Real Estate Index Fund ETF Shares (VNQ - Free Report)

The real estate corner of the broad market has been an area to watch lately given the market volatility that has returned the lure for rate-sensitive sectors. This is because these often act as a safe haven in times of market turbulence and concurrently offer higher returns due to their outsized yields. Additionally, rising rents due to shortage of homes and rising inflation are driving the sector higher (read: 5 Reasons Why REIT ETFs Are Surging).