Risk On Rally? These ETFs Say No

It seems like whenever the rally in the S&P 500 is discussed, at least when it is talked about in positive terms, it is associated with favorite Wall Street vernacular such as "risk on" and "animal spirits."

With the SPDR S&P 500 (NYSE:SPY) up almost 41 percent in the past three years, including dividends paid, it is not illogical to think risk on has ruled the roost over that time.

A closer examination of sector ETFs paints a different picture. As was highlighted on Monday, the Consumer Discretionary Select Sector SPDR (NYSE:XLY) has been the standout of the nine sector SPDRs funds over the past three years. Thing about XLY is the ETF has a beta of one against the S&P 500 and annualized volatility of 16.88 percent.

Said another way, XLY is not the most volatile, nor is it the riskiest ETF out there. Simply put, this has been a risk off rally and it has been that way for three years. Returns accrued by sector ETFs prove as much.

High Beta Disappoints...Sort Of Here is a trivia question: Excluding XLY, which is the only sector SPDR that is perceived as a high-beta play to outpace SPY over the past three years? Answer: The Energy Select Sector (NYSE:XLE). XLE has topped SPY by 350 basis points over that time while being 660 basis points more volatile.

The 23.1 percent gain for the Materials Select Sector SPDR (NYSE:XLB) only look good in comparison to the 19.4 percent gain for the Financial Select Sector SPDR (NYSE:XLF). Those ETFs have betas of 1.22 and 1.23, respectively, against the S&P 500.

Then there is the case of the Technology Select Sector SPDR (NYSE:XLK), an ETF perhaps best known for having one of the largest weights to Apple (NASDAQ:AAPL). XLK has a beta of 1.08 and annualized volatility of 16.16 percent, according to State Street data. Alright, so those number do not make XLK the most volatile ETF out there and it is up 36.1 percent in the past three years.

However, the SPDR options that have outperformed XLK, and XLB, XLE and XLF for that matter, might surprise those that are convinced this has been a risk on rally.

Low Beta Dominates Furthering the notion that investors have preferred sectors they perceive as less risky are the returns to the relevant SPDR ETFs over the past three years. Since March 23, 2010, the Consumer Staples Select Sector SPDR (NYSE:XLP) has surged 52.3 percent. The Health Care Select Sector SPDR (NYSE:XLE) is up 46 percent while the Utilities Select Sector SPDR is up 44.1 percent.

Here is an interesting and accurate way of looking at this rally: XLU has outperformed XLK by 800 basis points over the past three years while being 550 basis points less volatile. Moreover, investors have been paying up for the privilege of getting their hands on XLP's 0.63 and XLU's 0.47 betas. Both ETFs, XLU in particular, are richly valued on a historical basis.

Those that prefer riskier fare might be apt to say "Three years is a long time. Maybe the higher beta sectors have outperformed over narrower time horizons." Well, over the past two years, SPY is up 25.1 percent. Of the four riskier sector SPDRs highlighted here, only XLK is reasonably close to that performance with a gain of 23.1 percent.

XLU tops SPY's two-year run by nearly 700 basis points. Owning just XLP and XLV would have worked out even better. The average two-year returns to those ETFs is nearly 43.3 percent. Said another way, two ETFs that hold stocks such as Procter & Gamble (NYSE:PG), PepsiCo (NYSE:PEP), Pfizer (NYSE:PFE) and Merck (NYSE:MRK) have, when averaged together, nearly doubled the performance of XLK. XLK is home to Apple, Google (NASDAQ:GOOG) and sexier fare than P&G and Pfizer.

Things have not gotten any better for the risk on crowd in the past 12 months. Over that time, only XLF of the high beta ETFs highlighted here, has posted a double-digit gain. XLF has delivered returns of < href="http://www.etfreplay.com/charts.aspx">16.8 percent with 16.6 percent volatility. XLV, home to Johnson & Johnson (NYSE:JNJ), Pfizer and Merck, has outperformed XLF in the past 12 months by 800 basis points while being 550 basis points less volatile.

Surely, Apple and Google sound more exciting than P&G and PepsiCo, right? Well, there is little exciting about XLK's 1.9 percent return over the past year. The 20.3 percent offered by the far less volatile XLP is far more attractive.

Over the past six months, only XLF has topped XLP, XLU and XLV, but over the past 90 days XLF only tops XLU while lagging XLP and XLV. Risk on rally? Yeah, right.

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