Sector-oriented exchange-traded funds (ETFs) offer a way to gain exposure to an entire portfolio of companies that may be benefiting from trends in the market. They provide diversification from the business-specific risk of investing in just individual companies. They also allow the ability to play off different macroeconomic events that may favor some sectors while benefiting others. Here, we will go over which sector ETFs are the best buys right now, based on an aggregate of Wall Street analyst ratings.
Technology Sector Offers Largest Implied Upside in the Market
First up is the Technology Select Sector SPDR Fund (NYSEARCA: XLK). The fund provides exposure to 66 of the largest technology companies in the United States. These companies are all in the S&P 500, but the fund has provided significantly higher returns than the S&P 500 over the past five years. XLK’s total return of 173% over that period looks great compared to just under a 100% return for the Index.
Wall Street analysts are bullish on the technology sector. Among S&P 500 technology company ratings, 61% are Buys. Additionally, closing prices as of Sept. 6 are 23% below the aggregated price targets for the sector. This difference in current price and price targets is the largest of any sector.
However, it is important to note that technology valuations are elevated. The sector's forward price-to-earnings (P/E) ratio of 27x is 31% above its 10-year average. Still, it is hard to blame analysts for being bullish on the sector. In Q3, S&P 500 technology firms issued the highest percentage of positive earnings guidance of any sector and saw aggregate earnings surprises of 3.2% in Q2.
The rapid adoption of AI caused firms like NVIDIA to post massive earnings surprises in late 2023 and early 2024. The underestimation at that time is leaving analysts not wanting to be wrong again, raising their estimates for the future.
Energy Sector Offers Strong Revenue Growth and Upside Potential
Next up is the Energy Select Sector SPDR Fund (NYSEARCA: XLE). The fund provides access to 21 S&P 500 companies in the energy sector. When it comes to companies in this sector, 63% of Wall Street ratings are Buys, the second highest percentage among any sector. Also, the second highest among the sectors is the Sept. 6 closing price versus Wall Street price targets, which shows a difference of 21%.
Data also indicates that over the last few months, there may have been a misalignment between changes in the sector’s earnings growth estimates and the change in its price. Since Jun. 30, forward earnings per share estimates have increased by around 3%; however, the sector’s price appears to have changed by 1% or less.
Furthermore, the sector’s valuation suggests a potential opportunity. Compared to its 10-year average, the sector’s forward P/E ratio of 12x sits 24% below its 10-year average. The sector has also done a great job increasing its revenues, which grew by 8% last quarter from the previous year. This was second, only behind the technology sector. Additionally, all five sub-industry groups in the energy sector saw year-over-year revenue growth. This shows strength across the sector, not just one type of business supporting the rest.
The Communications Sector has the Highest Percentage of Wall Street Buy Ratings
Lastly, is the Communication Services Select Sector SPDR Fund (NYSEARCA: XLC). It provides exposure to 21 S&P 500 communication services companies. This sector boasts the highest percentage of company buy ratings from Wall Street analysts at 64%. Additionally, the Sept. 6 closing price differential from Wall Street price targets sits at 19.2%.
These three funds represent the only three sectors where that metric is higher than the overall S&P 500’s of 14%. The sector saw the third highest revenue growth of all sectors from the previous year at 7.5%. Four out of the sector's five industries saw double-digit revenue growth. The media industry saw a 1% decline.
The sector’s forward P/E ratio is 11% higher than its 10-year average; however, it is still significantly lower than the overall S&P 500’s of 21x.
