David Kotok: Why I'm Buying Health Care Now

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David Kotok of Cumberland Advisors is one of the most established ETF-focused financial advisors in the world. With $1.9 billion in assets under management and a 39-year track record, Cumberland has been a leader in the independent, fee-for-service money management business through multiple booms, busts and fads.

Kotok recently published a book-"From Bear to Bull With ETFs"-explaining how he uses sector-based ETFs to invest during both boom and bust cycles in the market. IndexUniverse's Global Head of Editorial, Matt Hougan, who wrote the foreword to the book, caught up with Kotok recently to discuss the book and his outlook for the market today.

IndexUniverse: You recently wrote a book on sector investing with ETFs. Why are sectors a useful way to approach the market?

Kotok: The benchmark for the U.S. stock market is the S&P 500 Index. It is composed of sectors and they are key to gaining performance. The ETF choices among the sectors facilitate this process. Choosing a sector to overweight or underweight requires macro inputs and a rationale for the decision. This is coupled with selection of broader characteristics such as growth vs. value or large-cap vs. small-cap. In some cases, you can combine them.

IndexUniverse: Which two U.S. sectors look the most attractive to you right now and how are you investing in them with ETFs?

Kotok: We like the health care sector. The broad-based ETF is XLV [the Select Sector SPDRs - Healthcare (NYSEArca:XLV)], and we hold it.

This sector has been maligned for years. Prices of the stocks were depressed because of fear of government intervention in the industry and imposition of price controls. We think all the bad news is known and the stock prices reflect the worst-case outcomes. Meanwhile, the health care industry, in the broadest sense, is 17 percent of the U.S. GDP and growing. The growth is unstoppable since we have a more affluent, aging population. Thus, the ETFs are cheap.

In addition to XLV, we like the health care equipment companies. They are more resistant to government intervention, which tends to focus more on the drugs than on mechanical devices or passive equipment. Thus, we like IHI, the iShares ETF [iShares Dow Jones U.S. Medical Devices ETF (NYSEArca:IHI)]. An additional way to play the health care sector is in the smaller-cap growth companies. PowerShares has a small-cap health care ETF that has characteristics that delve into the growth possibilities. Our choice ETF in this space is PSCH [the PowerShares S&P SmallCap Health Care Portfolio (NYSEArca:PSCH)].

IndexUniverse: Which U.S. sectors looks the least appealing to you right now, and why?

Kotok: The telecommunications sector and the utilities sectors are out of favor. They are usually defensive plays and this market is looking for growth, not defense. We have sold our positions in these two sectors. We previously owned XLU [the Select Sector SPDR - Utilities (NYSEArca:XLU)] and the iShares Dow Jones US Telecom ETF (NYSEArca:IYZ).

IndexUniverse: Are sectors global? Does it make more sense to buy a "global Financials" ETF instead of a "U.S. Financials" ETF, or do country-specific sectors still matter?

Kotok: Global influences are large. This is especially true in industry groups where the heavy share of profits is earned abroad. Intel is in the tech sector; it earns large portions of its profits from foreign sources. Pharma companies like Pfizer do the same. So does Coca-Cola. Therefore, when you buy a sector or industry ETF where these are large weights, you are investing globally and in baskets of companies with global exposure.

Likewise, a commodity-oriented ETF functions in a similar way. XLE [the Select Sector SPDR - Energy] is the basic energy sector ETF. Its heaviest weight is Exxon and Chevron, both massive global companies. Other ways to play in this sector are IEZ [the iShares Dow Jones US Oil Equipment & Services (NYSEArca:IEZ)], which involves oil services. IEX and XES [the SPDR S&P Oil & Gas Equipment & Services ETF (NYSEArca:XES)] get you deeper into drilling and equipment. A mix of these allows the investor to alter the overall weight and emphasize drilling and exploration, and lessens exposure to refining and downstream marketing. Rebalancing can allow this position to be reversed while remaining in the energy sector for an overall portfolio weight.

IndexUniverse: What is your outlook on global equity markets for the remainder of the year? What are the biggest risks to the market's recent strong move?

Kotok: The bull market started on Oct. 3, 2011. I discussed it in detail in my book. The market is following a pathway similar to other bull markets that occurred after a nonrecession bear market. We had a nonrecession bear market from April 29, 2011 to Oct. 3. If we track the median outcome of the past World War II periods, this bull market is only half over. It could take another 10 to 30 months to gain the other half.

Of course, there are many outside influences that could alter this forecast. The Fed is unlikely to move off the zero interest rate boundary in 2012. However, it could, and that would be a game-changing event. Markets are also focused on Europe and the workout there is not complete by any means. Spain is the latest poster child of a troubled debt problem. Italy and Portugal are also in that limelight. In southern Europe, the economies are shrinking, not growing. When there is not growth, the debt burdens become increasingly harsh. The debt burdens are now the source of political risk.

I could go on and list risks for hours. The issue at hand is if the U.S.-focused investor wants to bet on the risk outcome or wants to favor a position that reflects ongoing slow but gradually improving U.S. economics. I choose the latter.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: IEZ , IHI , IYZ , PSCH , XLV

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