ETF strategies helped pivot investors ‘away from consumer discretionary tech’: Expert

Pacer ETFs President Sean O’Hara joins Yahoo Finance Live to weigh in on the state of the ETF market and shares his thoughts on the Fed's approach to tamp down inflation.

Video Transcript

DAVE BRIGGS: Markets tumbling after Fed Chair Jay Powell reiterated his hawkish stance and warned of more pain ahead. The S&P 500 ETF ticker SPY selling off on the news.

For more on this and the road ahead we have Sean O'Hara with us, Pacer ETFs president, as part of this week's ETF Report brought to you by Invesco QQQ. Nice to see you, sir. If there was an enduring message from Jerome Powell that's reflecting in the markets today, what is it?

SEAN O'HARA: That they're not giving up. They're still committed to trying to stem the tide of rising prices and inflation. They're not convinced that their job is over yet, and so we'll have to continue to watch what they do.

It's a little surprising, to be honest with you, that we had some bad economic numbers on the manufacturing side. We had some bad retail-sales numbers this morning come out. And so it looks like what they've been doing-- which, sadly, is trying to destroy a certain part of the growth of the economy to tamp down inflation-- is starting to work, and so it's a little surprising that the market doesn't view that as a potential, you know, good-news story in the bad news that's wrapped up in it because it would be an indication that what they've done so far is accomplishing their goal and perhaps they don't need to be quite as aggressive as they have been. But as of yesterday's-- Mr. Powell's speech yesterday after the meeting, it doesn't look like they're going to stop along their path of continuing to raise interest rates.

SEANA SMITH: So, Sean, what does all this mean then in terms of a risk of recession, and if we do get a recession, potentially how deep could that be?

SEAN O'HARA: Well, you know, I think it's possible we're already sort of in a recession, you know? And we got here because the Fed said that inflation was transitory, and so it got away from them, right? And so now they're having to be sort of overly aggressive to kind of rein things in, and I'm concerned that that overaggressiveness might not result in what they're hoping for, which is sort of a soft landing. I think we may have a little-- potentially a little bit harder landing than what people think.

And so, you know, if there's good news in that, you know, historically speaking, that the stock market tends to react six months in advance of that recession starting. And so if we're nearer to this recession starting, if there's going to be one, and if there's a silver lining in there anywhere, we may be closer to a near-term bottom in the market.

DAVE BRIGGS: So given what we're seeing in the market today and your prediction of a hard landing, what are you telling investors? Any sector safe to hide?

SEAN O'HARA: Well, you know, this year, you know, we've succeeded in creating positive returns from one of our large-cap ETFs, COWZ, by positioning the portfolio in energy, health care, and materials and moving away from consumer discretionary and tech. It's not likely that-- not likely that that will change any time soon, so I think you have to be in some of the more defensive sectors.

I think if you think about, you know, where to invest in this kind of environment, high-quality stocks that generate a lot of free cash flow, that have a high free cash flow yield are things we love. They tend to pay dividends, grow dividends, and buy back their stock. Or strategies that people can use to sort of mitigate some of the downside risk, and we have a strategy that-- ALTL is that ticker, and it moves from high beta to low vol, and it's been in low vol most of this year. And so on a day like today it's down a little bit, but it's only down about what half the market's down. And so those types of strategies in this type of environment have worked out pretty well for the investors here at Pacer ETFs in Malvern.

SEANA SMITH: You know, Sean, within the health-care sector, that's interesting because we know the health-care sector has fared better than the S&P this year. When you take a look at BlackRock and also Fidelity, they have two large health-care ETFs that have actually outperformed the S&P by about 10% year to date. More specifically, when you're looking within that sector, I guess, how are you picking out the winners and losers?

SEAN O'HARA: Well, we screened for free-cash-flow yield. So the free-cash-flow yield is the free cash flow a company generates divided by its enterprise value, and enterprise value is market cap plus debt minus cash. So it's essentially a calculation that says what am I going to pay in total to buy stock and how much free cash flow will it give me in terms of current return? And so that's what's led us to the health-care sector.

You know, earlier this year energy was carrying all the weight for our portfolios because we were very, very heavily weighted energy. We still are. But I looked yesterday, and I think six out of our top 10 names are health-care names like Moderna, Regeneron. You know, Gilead is in our portfolio. AbbVie's in the portfolio.

So, you know, the interesting thing about the health-care sector, Seana, is that it's the only sector that has not seen, over the last decade or so, its stock prices go up faster than its earnings. You know, tech at one point had seen their stock prices go up more than double their earnings. And so that's what I think we're seeing in the tech sector right now is sort of a compression of that multiple. Same thing is happening to growth stocks broadly.

But health care, the stock prices actually went up less than their overall earnings. So we're not subject to that same multiple contraction in health care. And so as a defensive place to be, it's been a real big winner for us.

SEANA SMITH: The message here, stay defensive, at least for the first part of next year.

Sean O'Hara, great to have you. Thanks for joining the show this afternoon.

SEAN O'HARA: Thank you so much.