XLF Financial Select Sector

This has been an eventful week for the broad U.S. markets, with two impending government financial deadlines. All eyes are currently on the political gridlock (between White House and Republican lawmakers) over government funding and the debt ceiling as the new fiscal year is about to begin on October 1^st.
 
Fears over the possible government shutdown are growing if Congress does not pass a federal budget before September 30^th. Additionally, the government is seeking an increase in the debt ceiling, which expires on October 17^th.
 
Budget Debate Creeps In
 
Republicans are demanding expenditure cuts of an equal amount in exchange for the increase in the $16.7 trillion debt limit. However, President Barrack Obama does not favor any cut in spending to raise the limit of borrowing. This talk resulted in a dispute between the two and a failure to reach a higher debt limit could shake the financial markets and hamper consumer confidence.
 
The U.S. Treasury bond is the benchmark of the world's financial markets. The government has avoided any default so far, but could begin a technical default by the end of October or mid November if Congress does not approve the increase, as only $30 billion in Treasury cash would be left by the deadline (read: Time to Buy Treasury Bond ETFs?).
 
This debate reminds us of a similar situation two years back when Standard & Poor’s downgraded the pristine AAA credit rating for the country. At that time, the White House and Republicans disagreed on spending cuts and other key budget issues, leading to a similar investor alarm.      
 
ETFs to Watch
 
Given the looming budget battle in Congress, the following three sector ETFs are in focus this week and will remain so in the next. These products could see adverse trading conditions should the government fail to raise the debt limit:
 
iShares Dow Jones U.S. Aerospace & Defense Index Fund (ITA)
 
This fund provides broad exposure to the aerospace and defense industry by tracking the Dow Jones U.S. Select Aerospace & Defense Index. The fund has accumulated $190.3 million in AUM while charging 46 bps in fees a year. Volume is light, probably increasing the total cost for the fund.
 
With holdings of 38 stocks, the fund allocates higher weight to the top two firms – United Technologies (UTX) and Boeing (BA) – at 9.82% and 9.55%, respectively. Other securities do not hold more than 6.26% of total assets. From a sector perspective, aerospace has been the top priority representing 55.7% of ITA while defense takes the remainder of the basket.
 
The ETF lost about 2.5% in the last five trading session while it is up 36.16% in the year-to-date time frame (read: Play a Surging Defense Industry with These 3 ETFs). The fund currently has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with ‘Low’ risk outlook. This suggests that the product is expected to outperform its peers over the next one year.
 
SPDR Health Care Select Sector Fund (XLV)
 
This is by far the most popular and liquid choice in the healthcare space with AUM of over $7.5 billion and average daily volume of roughly eight million shares. The fund follows the S&P Health Care Select Sector Index and charges just 18 bps in fees a year (see: all the Healthcare ETFs here).
 
In total, the product holds 57 securities and is heavily dependent on the top three firms – Johnson & Johnson (JNJ), Pfizer (PFE) and Merck (MRK) – at 12.65%, 9.67% and 7.07%, respectively. In terms of sector holdings, pharmaceuticals take the top spot with 45% share while biotechnology (18.54%), providers & equipment (16.03%) and equipment & suppliers (15.67%) round out the next three spots.
 
XLV is down nearly 2.6% in the past five days but gained over 28% so far this year. The fund currently has a Zacks ETF Rank of 3 or ‘Hold’ rating with ‘Low’ risk outlook.
 
Financial Select Sector SPDR Fund ETF (XLF)
 
This is the largest and cheapest fund in the financials space, charging just 0.18% in expenses. The fund tracks S&P Financial Select Sector Index and has amassed over $15 billion in its asset base. Volume is massive, trading in more than 46 million shares a day.
 
The product holds 83 securities in its basket, with top allocations to Berkshire Hathaway (BRK.A), Wells Fargo (WFC) and JP Morgan (JPM). These securities make up for a combined 24% share. The ETF is quite spread across sectors with diversified financial service taking 32.19% share, followed by insurance and commercial banks with at least 17% share each.
 
XLF also lost around 2.4% in the past five sessions but is up nearly 24% YTD. The product currently has a Zacks ETF Rank of 2 or ‘Buy’ rating with ‘Low’ risk outlook (read: Financial ETFs Tumble on Citigroup Warning).
 
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ISHARS-US AEROS (ITA): ETF Research Reports
 
SPDR-FINL SELS (XLF): ETF Research Reports
 
SPDR-HLTH CR (XLV): ETF Research Reports
 
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