ETF Wrap: Investors piling into healthcare ETFs points to defensive bets, ‘bottom-fishing’ in biotech

Healthcare ETFs are attracting unprecedented capital this year as many investors seek to position their portfolios defensively amid growing fears the U.S. may be facing a recession. 

Investors have poured a record $9.6 billion into exchange-traded funds focused on healthcare through July 8, with the healthcare Select Sector SPDR Fund
XLV,
-0.27%
taking in $5.7 billion of those 2022 inflows, according to Todd Sohn, an ETF strategist at macro research firm Strategas. “That’s a huge chunk,” he said by phone.

The popularity of the healthcare Select Sector SPDR Fund, whose holdings include managed care stocks such UnitedHealth Group Inc.
UNH,
+0.43%
and big pharmaceutical names such as Pfizer Inc.
PFE,
-1.31%,
represents a desire for defensive positioning amid slowing growth concerns, according to Sohn. He said a majority of the ETF’s portfolio has exposure to the top quintile of stocks near a 52-week high.

While the ETF has fallen this year along with the broader stock market, it’s so far beating major U.S. stock benchmarks including the S&P 500
SPX,
-0.30%,
Dow Jones Industrial Average
DJIA,
-0.46%
and Nasdaq Composite
COMP,
+0.03%.
Shares of the fund have slid 9.5% this year through Wednesday, compared with the S&P 500’s drop of 20.2% over the same period, FactSet data show. 

“It’s reasonable to assume that in the coming months we’ll be in an environment of 1) Materially slowing growth and 2) A peak in inflation, and in that set up, bond yields should be declining,” wrote Tom Essaye, founder and president of Sevens Report Research, in a note Thursday.

“In that environment,” he said in the note, “we want to make sure we’re overweight defensive sectors because the main influence on markets should become slowing growth, not rising yields and inflation.”

From a sector allocation standpoint, that means considering ETFs such as the healthcare Select Sector SPDR Fund as well as the Consumer Staples Select Sector SPDR Fund
XLP,
+0.10%,
Utilities Select Sector SPDR Fund
XLU,
-0.03%
and Real Estate Select Sector SPDR Fund
XLRE,
-1.01%,
the note suggests.

The $9.6 billion of inflows into healthcare ETFs this year surpass the total $7.3 billion they attracted in all of 2021 and the $9 billion garnered in 2020, according to Sohn’s research. “It’s amazing that it’s July and healthcare sector flows” already are at an annual record, he said. “It’s double the amount of inflows that consumer staples has seen, which is the next highest sector in terms of flows.”

The Sevens Report said that from “a broad ETF standpoint,” investors might also consider the Invesco S&P 500 Low Volatility ETF
SPLV,
-0.57%
and the iShares MSCI USA Min Vol Factor ETF
USMV,
-0.26%
for an environment of slowing growth and peak inflation as in such a setup bond yields should be declining.

“That set up should also favor super-cap tech,” Essaye said in the report, pointing to companies such as Microsoft Corp.
MSFT,
+0.54%,
Google parent Alphabet Inc.
GOOGL,
-0.89%,
Oracle Corp.
ORCL,
-0.79%
and Cisco Systems Inc.
CSCO,
-0.87%

The “positive” side of the Federal Reserve aggressively hiking interest rates to fight the soaring cost of living while the odds of a recession rise is that “the majority of the increase in inflation is likely behind us,” he said. “So while we can’t say we’re at a peak right now, it’s likely coming within the next month or two or three.”

‘Bottom-fishing’

The heavy stream of capital flowing into healthcare ETFs this year included large contributions to funds that invest in biotechnology, where Strategas’s Sohn said some investors appear to be “bottom-fishing” for beaten down stocks.

The SPDR S&P Biotech ETF
XBI,
-2.28%
pulled in the second largest inflows among healthcare ETFs at $2.3 billion, followed by the “triple leveraged” Direxion Daily S&P Biotech Bull 3X Shares
LABU,
-6.60%
at $1.05 billion, Sohn said. Both funds have suffered big losses this year.

Direxion Daily S&P Biotech Bull 3X Shares has tanked about 74% in 2022 through Wednesday, while the SPDR S&P Biotech ETF was down almost 26% over the same period, according to FactSet data. Sohn said that about half of the SPDR S&P Biotech ETF’s holdings were trading near a 52-week low as of July 8. 

That’s “a sign of a much weaker portfolio,” he said. “But it could bounce.”

‘Mild recession’

The stock market has been volatile in 2022, with rising interest rates hurting valuations and investors now anxious about a potentially looming recession. Economists at Bank of America said in a BofA Global Research note Wednesday that they now forecast a “mild recession” in the U.S. this year. 

“Key headwinds include inflation and financial conditions,” they said. “With much of the recent rise in inflation coming from food and energy prices, commodities that face relatively inelastic demand in the short run, households may have less available for discretionary purchases.”

Read: U.S. inflation climbs to new 41-year high of 9.1%, CPI shows, as gas prices surge

Chris Huemmer, senior investment strategist for FlexShares ETFs at Northern Trust Corp.’s asset management division said by phone that he expects to see “more increased volatility” in the market in the second half of 2022 as historically that tends to happen in periods of an economic slowdown or contraction.

“Taking a low volatility approach to equities would make a lot of sense in that kind of a volatile environment,” he said.

The FlexShares US Quality Low Volatility Index Fund
QLV,
-0.23%,
which has exposure across sectors, has fallen 13% this year through Wednesday, FactSet data show.

“We want to own all the sectors and still deliver a low volatility portfolio,” Huemmer said of the fund. “We control for sector exposure, so we’re not too” overweight or underweight any single sector.

As usual, here’s your look at the top and bottom performing ETFs over the past week through Wednesday, according to FactSet data.

The good…

…and the bad

New ETFs

• Advisors Asset Management said July 12 that it launched the AAM Transformers ETF
  TRFM,
  +0.19%
  to target companies with the potential to transform consumer behavior, technological innovation and the global economy. The fund “seeks to track the investment results of the Pence Transformers Index,” according to the statement.

• RiverNorth Capital Management and TrueMark Investments announced on July 12 the launch of the RiverNorth Enhanced Pre-Merger SPAC ETF
  SPCZ,
  -0.10%,
  an actively managed fund that invests in premerger securities of special-purpose acquisition companies. The ETF uses leverage “opportunistically” based on valuations, according to the announcement.

Weekly ETF reads