The S&P 500, the Nasdaq and the Dow Jones – all underperformed in the third quarter of 2023, having lost about 3.7%, 4.1% and 2.6%. But the fourth quarter may not see such turbulent trading as it includes all-important holiday season.Over the past decade, the fourth quarter of the year has actually been the best for the stock market, with the Dow, S&P 500 and Nasdaq up at least 4% on average, per a CNBC article.

The S&P 500 had traded positively 80% of the time, according to a CNBC analysis of Kensho, a market data analysis platform. The Dow Jones Industrial Average had added 5% in fourth quarters over the past 10 years, trading positive 80% of the time.

Agreed, the Fed is likely to enact a rate hike in November. Inflationary pressure, rising rate worries and economic slowdown fears are present. But those threats are currently priced in the valuation. Moreover, inflation is falling and rates are peaking. Against this backdrop, below we highlight a few sector ETFs that could be great picks for Q4.

Sector ETFs in Focus

Financials – Financial Select Sector SPDR ETF (XLF Quick QuoteXLF - Free Report) ) – Zacks Rank #1 (Strong Buy)

As of Sep 29, 2023, the 10-year U.S. treasury yield was 4.59% and the two-year U.S. treasury bond yields were 5.03%. On the other hand, at the start of the month, the 10-year U.S. treasury yield was 4.18% and the two-year U.S. treasury bond yields were 4.87%. This indicates that the spread between two yields has been increasing, resulting in a steepening of the yield curve, which is great for banking stocks’ operation as it boosts net interest margin. If the trend continues, the cheaper valuation of the financial sector will give it a leeway to outperform in Q4 (read: 3 Factors to Bet on Bank ETFs Now).

Technology – Technology Select Sector SPDR ETF (XLK Quick QuoteXLK - Free Report) ) – Zacks Rank #1

Technology has turned out to be the most profitable sector so far this year, driven by the artificial intelligence (AI) boom, easing inflation and a surge in “magnificent seven.” Bets that the Fed will soon end its tightening policy may drive the sector even higher. The slump in the sector’s performance in the third quarter due to higher rates, corrected sector’s valuation too. Investors should note that consumers often buy and gift tech gadgets in the holiday season. This should make XLK a winning proposition.

Consumer Discretionary – Invesco S&P SmallCap Consumer Discretionary ETF (PSCD Quick QuotePSCD - Free Report) ) – Zacks Rank #2

The late October-December period embraces the key holiday season, which puts the spotlight on the performance of retailers. As loads of sales-boosting events — Halloween, Thanksgiving, Cyber Monday, Black Friday and Christmas — fall in this quartile, the sector generally sees a sales boost.

This holiday season, running November 1 through December 24, U.S. retail sales barring automotive are expected to rise 3.7% year over year, per Mastercard SpendingPulse. As a result, the small-cap consumer discretionary sector, which has less exposure to global markets, has every chance to outperform in Q4. 

Transportation– SPDR S&P Transportation ETF (XTN Quick QuoteXTN - Free Report) ) – Zacks Rank #2

Thanksgiving and Christmas are normally two of the most traveled holidays in the fourth quarter. A surge in travel is expected this holiday season, especially with Christmas Eve and New Year's Eve falling over the weekend. High demand for holiday travel and rising fuel prices may push prices up for tickets for airlines and other mode of travelling. This makes transportation stocks, as a whole, a great buy for Q4.