August 3, 2025
Last week we noted that the S&P 500 had made it into overbought territory. We ended last week with some selling on weak employment data which is obviously untrue. Regardless of statistical truth, all the rational participants in the stock market need to keep in mind that feelings are real. If we feel fear as investors more than we feel optimism, we’re going to sell, especially if we see other people doing it. This is the trump card “no pun intended” that the market technician holds. There may be a rational value for everything, but, while an individual is capable of rationality, no one ever wrote about the rationality of crowds. This brings us to the focus of our letter. There’s been a big spread between higher- beta Growth stocks and almost everything else developing since equities pivoted from their lows on April 7th. In our sector world, it’s been all Tech.
Looking at the performance of the SPDRs (chart below), we can see that Tech has accrued a majority of the outperformance since early April outpacing the S&P 500 by >10% during that time. Healthcare stocks have been obliterated over the same period, lagging the index by more than 20% while Materials, Staples and Real Estate have also lagged by double-digits. Industrial stocks have also been marginal outperformers, but the other 9 sectors have given up ground and we think the setup invites rotation.
The dilemma is that we are in a bull market, or at least we all thought we were 5 days ago. Investing in Tech stocks may indeed be the best way to get rich, so how do we navigate a situation where Growth stocks have momentum, inflation is a concern, and a slowing economy is also a concern? Low vol. securities like SPLV or XLU (which we’re currently using in our Elev8 strategy) are a traditional equity portfolios de-risk, but they pose some dilemmas when there is potential that the bull market is still alive and well.
A strategy we’ve been developing is using an equal weight sector fund like EQL as a hedging tool for our sector rotation model rather than a low vol. fund or a bond fund. In the current environment, EQL offers some characteristics that can be very helpful for managing the current set of risks investors are presented with. We think that in addition to downside risk mitigation, the most important considerations are inflation risk, interest rate risk and opportunity cost of going to low beta in a longer-term bull market. EQL is a helpful tool for these use cases. We’ll illustrate with a comparison of EQL and SPLV where there are some interesting takeaways.
Inflation and Rate Risk Mitigation
Conceptually, inflation is structurally rising prices due to scarcity or increased demand. With the business cycle still in expansion and trade war dynamics still playing out, we have those conditions in place today. Historically inflation has been accompanied by rising Commodities prices and rising interest rates. Looking at our Macro Trend Study of sector excess returns coincident to historical macro trends (table below), we can see that the best sector exposures for rising Commodities prices are Energy, Materials, Tech and Financials. For rising interest rates, the best sectors are Tech, Discretionary, Industrials and Energy. While low vol. sectors do their best work when the equity price trend is down, they don’t historically do well when Commodities prices are rising and rates are rising, nor when USD is falling as it has been in 2025.
EQL, which is an equal sector weight strategy with around 9% of its assets allocated into each sector fits in differently. It offers overweight exposures vs. the S&P 500 in Energy, Materials, Utilities, Staples and Real Estate. It’s roughly market weight in Discretionary, Industrials Comm. Services and Healthcare and is materially underexposed to Tech and Financial shares. This allows for a broader amount of diversification and historically it has also had better upside capture. Low vol. does better if we know equities are going lower, but if there are multiple likely outcomes involving inflation, the EQL exposure is more flexible based on its historical return profile.
Low Vol has Higher Performance Volatility
When we look at long-term performance of EQL and SPLV it’s interesting to note that while SPLV statistically has a lower beta coefficient (currently 0.58, the EQL sports a beta coefficient of 1), the EQL offers less volatile performance vs. the S&P 500. Below, we consider the XLK with each the EQL and the SPLV. Both funds are positively correlated on direction of price returns but negatively correlated on performance. What we think may be underappreciated is that running strategies that switch between a risk-on and risk-off footing is not an exact science. If we all could switch to safety right before a price decline, the investing world would likely be very different. So, when considering the charts below, keep in mind that EQL may not deliver quite as much downside capture when equities are in sustained correction, but over the past 5 years, it’s captured 92% of the S&P 500’s total return, while the SPLV has only captured 73% of it. If signals are late or early, or strategies have monthly or quarterly rebalance schedules this can be a detriment to performance that EQL can help with.
XLK and EQL
XLK and SPLV
Conclusion
Today’s equity investor faces a different world than most of us grew up in the markets with. Inflation is a concern in a more permanent way than when zero interest rate policy dominated after the Global Financial Crisis. Interest rates are higher and global trade is fragmenting which presents opportunities, but also inefficiencies. Thinking about risk in terms of volatility and drawdowns still matters, but with inflation a factor, it may not be as obvious what categories of stocks will act as safety. Hedging with an instrument like EQL offers some increased flexibility to cover a broader set of less correlated exposures. As a trend following investor who likes to be in momentum stocks when prices are moving a higher, the EQL ETF offers a complimentary strategy that allows for downside capture and tracks the S&P 500’s performance through a cycle better than traditional low vol. exposures like SPLV. Something to consider as global trade concerns pressure the bull trend.
Patrick Torbert, Editor & Chief Strategist, ETFSector.com
Data sourced from FactSet Research Systems Inc.
