Warren Buffett likes index funds — especially those that track the S&P 500.
“In my opinion, owning the S&P 500 index fund is best for most people,” he once said.
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However, according to Savita Subramanian, Bank of America’s head of US equity and quantitative strategy, this strategy may not be optimal in the current market environment.
“The worst thing to hold is the S&P 500 wholesale,” she tells CNBC.
While following the benchmark index has worked well over the past decade, Subramanian notes that the current environment is different.
“The S&P 500 is expensive right now – it’s super full. It’s the most-watched ticker in the world when you look at it from an index perspective.”
She still likes Buffett’s long-term approach. But adds that investors have different time horizons.
“If you have a 10-year time horizon, hold the S&P 500 and watch and wait,” she recommends. “But if you think about what’s going to happen between now and say the next 12 months, I don’t think the bottom has been reached.”
Of course, that doesn’t mean you should divest stocks entirely. Here’s a look at what Subramanian still likes in today’s market.
While Subramanian doesn’t find the large-cap-focused S&P 500 attractive right now, she does see opportunities in the small-cap space.
“If you think about the small-cap benchmark, it’s pricing in a hard landing, a deep, deep recession,” she says.
“We believe they will be fine. We think we’re going to get a recession, but it’s going to be a softer landing.”
Investors can use ETFs to gain exposure to small-cap companies. Funds like the Vanguard S&P Small-Cap 600 ETF (VIOO) and the iShares Russell 2000 ETF (IWM) could provide a good starting point for further research.
Subramanian has long been energy optimistic.
“I would look for sectors that are benefiting from what is still a very high inflation backdrop. I would buy energy,” she says.
While rampant inflation has cast a huge shadow over the stock market, energy stocks have been firing on all cylinders.
In fact, energy was the best-performing sector of the S&P 500 in 2021, delivering a total return of 53% versus the index’s 27% return. And this momentum will continue into 2022.
Year to date, the Energy Select Sector SPDR Fund (XLE) is up a solid 35%, in stark contrast to the double-digit decline in the broader market.
Unlike the energy sector, the industrials sector was not a favorite of the market. But Subramanian sees a revival on the horizon.
“I would buy select industrials that could benefit from a CAPEX cycle that we see underway,” she says. “Everyone is pulling companies back to the US, it’s going to benefit traditional industrial companies from a more traditional CAPEX cycle rather than spending on technology.”
Certainly Subramanian speaks of “selected industries”.
So how do you choose? The key is in automation.
“I think the best place within the industrial complex is some of the automation games because if you think about it, that’s where companies are spending money.”
Subramanian explains that there is also inflation in the labor market.
Therefore, when companies bring jobs back to the US, they are “driven to automate more processes” than if they could “outsource and pay for super-cheap labor” in other countries.
Health care is a classic example of a defensive sector as it is uncorrelated to the ebb and flow of the economy.
At the same time, the sector offers great long-term growth potential due to favorable demographic tailwinds – particularly an aging population – and numerous innovations.
Subramanian finds the sector attractive.
“I think healthcare is looking great, it has a lot of free cash flow yields,” she says.
It might be difficult for the average investor to pick specific healthcare stocks. But healthcare ETFs can offer a diversified way of gaining exposure to this space.
The Vanguard Health Care ETF (VHT) offers investors broad exposure to the healthcare sector.
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This article is informational only and should not be construed as advice. It is provided without any guarantee.