SPY or XLK: Which ETF to Invest In
Are tech stocks overpriced?
Much has been said that technology stocks are dangerously overpriced and have delivered returns that are too good to be sustained into the future. Let’s examine the broad market of the S&P 500 and its sectors, including the technology sector within the S&P 500, focusing on SPY or XLK.
To do that, we will look at the SPY ETF and all the 11 sector ETFs that comprise the SPY. We will use data supplied by the sponsor of all those ETFs – State Street Global Advisors.
| Name | Description | Weight In SPY | PE | Earning Growth | 10 Yr Annual Return | Annual Return Since Inception | |
| SPY | 100% | 21,82 | 13,74% | 10,77% | 10,22% | ||
| 1 | XLK | Technology | 29,94% | 28,76 | 14,62% | 20,67% | 9,17% |
| 2 | XLF | Financial | 13,05% | 16,16 | 12,77% | 10,77% | 5,32% |
| 3 | XLV | Health Care | 12,29% | 19,11 | 13,06% | 11,11% | 8,96% |
| 4 | XLY | Consumer Discretionary | 10,36% | 24,21 | 14,16% | 12,02% | 9,58% |
| 5 | XLC | Communications | 9,01% | 17,37 | 18,33% | N/A | 9,40% |
| 6 | XLI | Industrial | 8,75% | 22,15 | 13,76% | 10,87% | 8,81% |
| 7 | XLP | Consumer Staples | 5,98% | 20,58 | 7,42% | 8,64% | 6,67% |
| 8 | XLE | Energy | 3,87% | 13,12 | -1,55% | 3,77% | 7,94% |
| 9 | XLB | Material | 2,35% | 21,86 | 7,91% | 8,59% | 8,28% |
| 10 | XLRE | Real Estate | 2,25% | 36 | 5,82% | 5,90% | 6,81% |
| 11 | XLU | Utilities | 2,15% | 16,03 | 7,38% | 7,89% | 6,71% |
Let’s make sure that the table is read correctly. SPY is the ETF tracking the S&P500 Index. As such, its weight is 100% of SPY. The PE Ratio of the ETF is 21,82, while the expected earnings growth rate, based on analysts’ estimates, is 13,74% per year.
XLK ETF: The Tech Sector in Focus
Moving on to XLK ETF – the technology sector ETF within the S&P500. The weight of the technology sector in the S&P500 is currently 29,94%. Here is an important note: some companies considered technology are not part of that sector.
For example, AMZN is in the Consumer Discretionary sector, while GOOG and META are in the communications sector. Going back to XLK – the valuations are pretty high; the PE ratio is 28,76, compared to 21,82 for SPY, and the expected earnings growth rate is 14,62%, while for SPY, it is 13,74%.
XLK vs. Other Key Sectors
You can look at the sectors individually; we will not review each sector individually but selectively. First, we will exclude XLC from investment consideration – the Communications sector ETF is comprised of companies that are far too different – we have GOOG and Meta on one side. On the other hand, we have T and VZ. Second, we will take a closer look at XLF and XLV. Both sectors have shown 10-year returns very close to SPY; their PE ratios are 10% and 25% lower than SPY, while their earnings growth rate is only 5% and 10% lower, respectively.
Compared to XLK, XLF’s PE ratio is 45% lower and XLV’s 35%, respectively, while at the same time, earnings growth rates are only 12% and 10% lower. XLV and XLF seem to have valuations that look much more attractive than those of SPY, especially XLK. But the main reason we are focusing on those two sectors is that the weight of the technology sector, XLK, at 29,94% in SPY, is close to the historical high for ANY industry over the last 30 years.
Ten years ago, the sector was only 15% of the index. This 10-year historical outperformance has created dangerously high expectations in investors that technology stocks deliver returns twice as high as the S&P500. This is certainly not true!
If we use a 25-year investment horizon, we will see that XLK and SPY provide similar returns. According to State Street Global Advisers, since inception in 1993, SPY has had a before-tax return of 10,22% annually, while XLK has had a before-tax return of 9,17% annually since 1998!
One crucial observation is that over the past decade, SPY has been outperformed by 5 of the 11 sectors that make up the ETF. However, SPY has beaten every sector regarding annualized returns since its inception.
This observation strongly suggests the presence of long-term seasonality in sector valuations, a factor that investors should consider when making investment decisions.
Long-term Returns: SPY’s Dominance and Sector Seasonality
Over the last ten years, the technology sector has delivered returns twice as good as those of the broader markets. The result of that success is that the sector’s capitalization within the S&P500 is nearly 30%. The sector’s valuations are also high compared to the broader market and other significant sectors like the financial or healthcare sectors.
However, what is concerning is that the sector’s expected growth rate is very close to that of the broader market. The high valuation and large capitalization are dangerous, making the sector vulnerable to corrections.
While we are not necessarily bearish on the sector, we prefer to allocate to the financial and healthcare sectors. We certainly think that risks in the technology sector may be pretty high and not justified by the expected returns.