The 3 Best Market Sectors for the Second Half of 2022

Inflation fears delivered the worst first-half performance for the stock market since 1970. Fortunately, the second half is unlikely to echo the destruction because equities have already baked in a mild recession. Indeed, many areas have arguably priced in a depression. If you agree with me, consider energy, technology and biotech top picks for the best market sectors to buy now.

The most compelling argument for stocks to do better in the second half of 2022 is that we’ve already seen so much damage. While the S&P 500 is only 20% off the highs, more speculative market areas like growth stocks, crypto, SPACs and the like have been utterly demolished. Meanwhile, corporate profits remain high, and although growth is slowing, the downshift has hardly been enough to warrant such widespread carnage. As is often the case, pessimists have overplayed their hand, and equity values have likely fallen too far too fast.

While long-term investors will do well buying anything at these levels, the bullish case for the following three market sectors is the most attractive.

Ticker Company Recent Price
XLE Energy Select Sector SPDR Fund $73.09
XLK Technology Select Sector SPDR Fund $134.14
XBI SPDR S&P Biotech ETF $81.30

Energy Sector SPDR Fund (XLE)

Source: The thinkorswim® platform from TD Ameritrade

Booming oil prices benefitted energy stocks in the first half of 2022. Even after a steep June decline, the Energy Select Sector SPDR Fund (NYSEARCA:XLE) still finished up 31% for the year’s first six months. And yet, new buyers are getting a much better entry because of the pullback. The valuations for many oil companies are still cheap, with many boasting price-to-earnings ratios in the single digits. Unless oil prices fall precipitously and torpedo corporate profits, the valuation angle for acquiring energy companies will remain compelling.

And even if you’re in the camp that a recession is imminent, it doesn’t have to mean that oil prices are destined for a massive reset ala 2008. Underinvestment in energy infrastructure has led to supply and demand imbalances that may leave prices elevated for an extended time. And that should keep buyers coming into XLE, making it one of the best market sectors to own for the rest of the year.

Consider the following call spread if you want a low-cost and leveraged way to play.

The Trade: Buy the XLE Dec $75/$85 bull call spread for $3.70.

You’re risking $3.70 to make $6.30 if XLE climbs past $85 by expiration.

Technology Select Sector SPDR Fund (XLK)

Source: The thinkorswim® platform from TD Ameritrade

The Technology Select Sector SPDR Fund (NYSEARCA:XLK) ended the year’s first half down 27%. Its fall from grace was driven by inflation and the end of easy money policies. Rising interest rates are incredibly unfriendly to growth stocks because of their heightened sensitivity to the discount rate for future cash flows. But the pessimism pendulum has swung so far, and the market has so quickly priced in the current rate hike cycle that any whiff of a dovish pivot from the Federal Reserve should bring buyers rushing back into growth.

And that will benefit the technology sector above all others. Commodity prices have already peaked, and further signs of an economic slowdown should give the Fed cover to ease off the brakes they’ve been slamming to the floor to combat runaway inflation.

At the same time, with so many tech giants trading in bear market territory, any mild retreat in earnings has already been discounted.

The Trade: Buy the Dec $140/$150 bull call spread for $3.75 or less.

You’re risking $3.75 to make $6.25 if XLK returns to $150 by year-end.

SPDR S&P Biotech ETF (XBI)

Source: The thinkorswim® platform from TD Ameritrade

The SPDR S&P Biotech ETF (NYSEARCA:XBI) is my final pick for the best market sectors to buy for the second half of 2022. In fairness, it’s technically an industry, not a sector, but close enough. Besides, I think XBI is a better play than buying the Health Care Select Sector SPDR Fund (NYSEARCA:XLV) because it’s equal weight to a broad swath of small-cap biotech companies. There are three reasons why I love this pick.

First, after falling 70% from its highs, XBI is in the bargain bin. It’s trading around 11 times forward earnings, and companies in the industry are expected to grow at nearly 20% annually for the next three to five years.

Second, acquisition activity is on the rise and should keep buyers interested. Recently Pfizer (NYSE:PFE) purchased Biohaven Pharmaceuticals (NYSE:BHVN), GlaxoSmithKline (NYSE:GSK) acquired Affinivax and Bristol Myers Squibb (NYSE:BMY) bought Turning Point Therapeutics (NASDAQ:TPTX). Last month, Merck (NYSE:MRK) began talks to buy Seagen (NASDAQ:SGEN).

Third, XBI is outperforming the S&P 500 off the lows and has already reversed its daily downtrend.

Buy XBI directly or use this options spread to amplify your returns.

The Trade: Buy the Dec $85/$95 bull call spread for $3.50.

You’re risking $3.50 to make $6.50 if XBI climbs beyond $95 by expiration.

On the date of publication, Tyler Craig was LONG XBI.

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