Confirming Risk On

Published on Friday, 27 January 2012 20:00 Written by Todd Shriber

New York, January 27^th (TradersHuddle.com) – The much-ballyhooed risk on trade looks like it has come back in 2012 following a year spent in hibernation. In 2011, investors shunned riskier fare at the sector level in favor of conservative standbys such as staples and utilities. That trend helped the Consumer Staples Select Sector SPDR (NYSE: XLP) and the Utilites Select Sector SPDR (NYSE: XLU) to stellar performances among sector ETFs.

Well, the leadership roles may be reversing and that could mean it’s time to embrace a fund like the Materials Select Sector SPDR (NYSE: XLB), which has gained 11% year-to-date. That compares to negative performances for both XLP and XLU.

There are plenty of materials ETFs on the market, though few can boast a stature comparable to XLB’s. The ETF has been around since 1998 and with an expense ratio of 0.2% and assets under management of $2billion, it’s safe to say XLB is one of the oldest, cheapest and largest materials ETFs on the market today.

XLB’s 30-stock lineup reads like a who’s who of U.S.-based companies associated with the risk on trade. That’s an important factor to note. XLB is exclusively devoted to U.S.-based materials companies. That means companies like BHP Billiton (NYSE: BHP) and Rio Tinto (NYSE: RIO) are not found in this ETF. Investors looking for some international flair with their materials exposure should checkout the iShares S&P Global Materials ETF (NYSE: MXI).

Back to XLB. Dow component DuPont (NYSE: DD), Freeport McMoRan (NYSE: FCX), the largest U.S. copper producer, and agriculture play Monsanto (NYSE: MON) account for over 30% of XLB’s weight. Three stocks representing almost a third of an ETF’s means that ETF can be top-heavy and that is what XLB is its top-10 holdings combine for almost two-thirds of the fund’s weight.

Other top-10 holdings investors may be familiar with include Dow Chemical (NYSE: DOW), Newmont Mining (NYSE: NEM), Mosaic (NYSE: MOS) and Nucor (NYSE: NUE). Put another way, if you’re looking for a temperature check on the health of the U.S. economy and confirmation regarding the validity of the risk on trade, XLB is one of the best bets out there.

Conversely, XLB is extremely sensitive to poor economic data and market environments where investors are playing defense. The ETF proved that during the financial crisis and again last year. Should concerns about another recession re-emerge; there is no good reason to expect XLB will go up. Those looking to hedge a position in XLB should consider the ProShares UltraShort Basic Materials (NYSE: SMN), but only as a short-term trading vehicle.

At the moment, the path of least resistance for materials stocks looks to be higher. Bad news for SMN, but great news for XLB.