Daniel Santiago (State Street): Sector ETFs, S&P Concentration, and Reading the Cycle

Daniel Santiago from State Street Global Advisors joins Michael A. Gayed, CFA to unpack sector ETF investing in 2026 — the original SPDR product line, now the largest and most liquid sector suite on the market. We get into the Magnificent Seven concentration problem in the S&P 500, how State Street's GICS-based classification actually works (including why SpaceX classifies as communication services), sector dispersion versus style/factor dispersion, and how to think about sector rotation given where we are in the economic cycle.

For allocators, advisors, and anyone building portfolios who wants a cleaner framework for reading the tape sector by sector.

Guest: Daniel Santiago, Sector ETF Specialist, State Street Global Advisors (SPDR)
Host: Michael A. Gayed, CFA — Publisher, The Lead-Lag Report

Watch on YouTube: https://www.youtube.com/watch?v=alSfJtl1xCI
More: https://leadlagreport.com

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Transcript

Welcome And Guest Background

SPEAKER_01 0:02

All right, folks. Uh appreciate those that are starting to watch this uh podcast. Uh it is going to be a good conversation and one that I have not had uh with my friend Mr. Daniel Santiago, who I've known for several years. I had uh gonna know him uh over the last uh iterations of my career, let's call it, in prior companies. And uh he's always been a friend and an advocate. And I said to him, listen, we should have you on Lead Leg Live given the kind of work you're doing at State Street. And since I have not done a conversation with somebody at State Street, I figured this is the right time to do it. Um, a lot of good topics we're gonna touch on. Uh, do me a favor, folks, as you're listening to this on Spotify, Apple, and hopefully watching the stream with the post-edited compliance approved version. Uh, make sure you like and repost it. Uh, there's a lot of great stuff that Daniel and his team are doing, and obviously State Street, it's a kind of a big company. So, with all that said, my name is Michael Guy, a publisher of the Lead Lag Report, founder of Lead Lag Media. Joining me is Mr. Daniel Santiago of State Street. Uh, Daniel, introduce yourself. A lot of people in the industry know who you are, but a lot of people outside of the industry don't. So, what's your background? What do you do at State Street?

SPEAKER_00 1:04

Yeah, absolutely. Happy to be here with you, Michael. So I sit on our sector ETF specialist team, and I'm responsible for promoting and uh providing education and thought leadership around their sector ETF suite here at State Street Investment Management. As you know, State Street created sector ETFs in 1998, and today our sector suite is the largest, most liquid, and lowest cost available on the market to investors.

SPEAKER_01 1:29

A lot of uh investors are familiar with sector investing, but while them also like to look uh much more granular sub-industries, or they like to look at themes as ways of investing.

Why Sector ETFs Beat Stock Picking

SPEAKER_01 1:38

Um, make the case for why sector ETF investing is maybe a better way of thinking about allocating, especially now, uh given where we are on the cycle.

SPEAKER_00 1:47

Yeah, absolutely. I think that the case for sector investing is you know pretty simple, right? Sector ETFs really sit at that sweet spot between owning the whole market and trying to pick individual names. They're really practical diversification tools that I believe that almost any portfolio can use. So if you buy the broad market today, you're probably taking on more megacap exposure than you realize. Every dollar into the SP 500 sends a very large amount into a small group of names within semiconductors and the Magnificent 7. So that can leave investors' portfolios either more or less concentrated than they intended. Um, also, stocks underpers underperform their respective sector in around 80% of years. Therefore, uh investors very oftentimes get the sector call right, but the stock call wrong. And sector ETFs allow investors to express their views on specific areas of the economy, like technology, industrials, healthcare, or even the energy sector without having to rely on the fate of one single stock in your portfolio. And with sectors, you really don't have to pick the one wear on the street. They really allow you to own the entire neighborhood. Um, you know, speaking about dispersion, sectors have exhibited significantly wider dispersion compared to style and factor investments. So when you look at a year like 2022, which is the worst year on record for US stocks and bonds combined, you can see that the difference between uh the top sector, energy, and the bottom sector, communication services, is over 100%. Whereas it's around 25% difference between style and factor investments in a volatile year like that. And since sector leadership evolves over time, investors can pursue alpha opportunities by overweighting the winning sectors in their portfolios and underweighting the laggards.

How Stocks Get Classified By Sector

SPEAKER_01 3:34

I always thought it was interesting, sort of the um the debate about how you define stocks within a particular sector, right? So when people talk about tech, right? I mean, there you can argue that almost every industry and sector to some extent is is tech, right? Um talk to talk to us a little bit about how State Street defines what makes a stock fit in a particular sector.

SPEAKER_00 3:54

Yeah, yeah, absolutely. So at State Street Investment Management, our sector ETFs draw from the S P 500, which is um, you know, follows the GIX framework. So I would say that technology is the largest sector in the SP 500. Right now, about oh, just over 30%. And the largest industry in the SP 500 is the semiconductor. This is also the dominant earnings driver of the S B. So when it comes to classification and how companies like SpaceX get classified as either a technology, a communications company, or an industrial company, it really relies on where their main revenue source is coming from. So, for example, in terms of SpaceX, because a majority of the revenue is coming from their Starlink satellite broadband business, the stock is actually being classified as a communication services stock.

SPEAKER_01 4:52

Yeah, and that that revenue point I think is important. It's like you have to be able to identify, because obviously that's what defines any any company is sort of where they're getting their revenue

Sector Rotation And The AI Build-Out

SPEAKER_01 5:00

from. Now, what also defines uh performance, you can argue, is where uh we are in the economic cycle. And there's a lot of interesting studies around how certain sectors will do better in growth periods versus tractionary periods versus recovery periods. Um, let's talk through how um allocators, how investors can think through how to apply sector ETFs based on where we are in the economic cycle.

SPEAKER_00 5:22

Yeah, this is actually one of my favorite use cases for implementing sectors, right? So let's talk a little bit about the economy, right? Right now, I would describe the economy as growing but unevenly, right? We're not really in a clean textbook expansion where every sector is going to behave as expected. And I think that that's why sector selection matters more now than ever. Um, so you know, one of the most simple and core use cases for sector investing is to follow the economic cycle and to position yourself in various um, you know, themes, industries, or sectors that are set to do well for the given environment. Um, for example, sector leadership um, you know, tends to change. So in an expansionary environment, you may favor the cyclical sectors like financials and technology, which are set to lead. And then in a more recessionary environment, you may want to overweight those more defensive sectors, think healthcare, utilities, and consumer staples. You know, what's making this environment really interesting is that we're really seeing elements of both of those environments, right? So there's parts of the market that are still reflecting expansionary behavior, especially when we're seeing like extremely clear earnings growth from these companies. There's a massive amount of capital spending and innovation happening, but there are other areas of the market that are behaving as if, you know, growth is becoming more fragile and sensitivity is becoming top of mind, right? In particular, technology looks really compelling right now. As I mentioned earlier, it's the dominant earnings driver of the SP 500. We continue to see upwards earnings revisions, and it's the only sector that's um, you know, growing based on multiple expansion as well. Um, it really remains at the epicenter of innovation. However, one of the things that is coming to the surface is the fact that AI is no longer just the tech and media story. This is really becoming more of like a real-world infrastructure build-out. And the AI economy is becoming more of a physical story. So it's not really just about chips, it's about the data centers, electricity, electrical equipment, power demand are all becoming increasingly important. So I think that this is really interesting because um, you know, take a look at a sector like utilities, right? I think that this is a sector that's gonna become more relevant than people think because of the electrification and power demand that we're seeing, you know, as a result of data centers and the AI build out. So if this demand continues alongside data center expansion, electrification, and grid investment, utilities are gonna start to look a lot more like an AI enabler than the bond proxy that investors have looked at them as in the past.

SPEAKER_01 8:02

Yeah,

Valuation Signals And What Looks Cheap

SPEAKER_01 8:03

a lot of people also think about sector uh from a sectors from a momentum perspective, right? Um, fundamentals obviously are what matter in the long term. So let's talk about some of the fundamentals of some of these sectors, you know, from a valuation perspective. How do we look in terms of what's cheap, what's expensive, what's just right, and you know, walk through sort of the uh the arguments for those that are looking more for more value uh in their portfolio.

SPEAKER_00 8:26

Absolutely. This is something that we watch really closely here at uh State Street. So every month we publish our chartback, and that's available on our website. And we also publish something called the State Street sector scorecard. I call it our dashboard, and it looks at valuation, it looks at momentum, and it looks at earning sentiment. So, in terms of valuation right now, the cheapest sectors are going to be um healthcare and financials. There's some up and real estate. Those sectors have not rallied as some of the other sectors that are more high octane growth have. In terms of momentum, we've seen a lot of price action, particularly in energy. And behind that, I would say is technology. In terms of earning sentiment, meaning earnings revisions, and um, these companies continue to be profitable, that is also led by both energy and technology.

SPEAKER_01 9:18

Yeah, I f I personally find this this interesting because um you always have people talking about oh, AI isn't a bubble. I myself have talked about that, you know, in I don't think it's a bubble in the traditional sense. Um, but it's true that when you look at the fundamentals, you know, the revenue's there. The four valuations are are pretty compelling, I think, overall. Um from your standpoint, if somebody's actually out there talking to advisors, allocators, high networkers, self-directed traders, um, where's the where's the interest the most and where's the skepticism the highest? Uh, just kind of talk about those two different areas because I think that's that that gives you a sense of sort of sort of where the the mindset of the marketplace is. Um and you know, you're on the ground, you're actually hearing and seeing what people are thinking and doing.

SPEAKER_00 10:02

Yeah, absolutely. So, you know, you think of a sector like technology, which you just spoke about, like I said, this that the earnings are real and the visibility is there well into 2027. Almost every single industry within the technology sector has higher earnings per share estimates than the S P 500 itself, including the beaten-down software sector or software industry. So, you know, one of the things that you have to remember in a market where there's rise in volatility, narrow leadership, a huge dispersion under the surface is that markets can keep moving higher, even when a relatively small group of stocks do the heavy lifting. And when volatility rises and sector leadership narrows, investors, in my opinion, should focus less on trying to predict some of these short-term moves and more on trying to find a balance within their portfolios. And one of the ways that I say that you can achieve that is to spread the love or to spread your exposure across some different drivers of return rather than relying on one narrow theme like technology. So, for example, investors compare some of the leading areas of growth like technology and communication services, which are set to be the kind of pure play AI beneficiaries, with sectors that are set to benefit as really the picks and shovels of the AI build-out, right? Think industrials, materials, and even in some cases, energy. Over the past year, we've really started, we've seen that in the flows and performance. Um, the investors are not really chasing one trade. They've really been allocating alongside tech to industrials, materials, and energy. You know, like I said, my practical solution is to balance your portfolio with intention. You probably want to keep exposure to some of these obvious leaders, like the semiconductor industry, but you also want to complement that with some sectors that can participate if market leadership starts to broaden or the next leg of the cycle is driven more by power demand and infrastructure as we sus we suspect.

SPEAKER_01 11:53

Yeah, and the utility side is always uh interesting. I mean, utilities are typically seen as the, you know, relatively safer, you know, nothing's really fully safe in investing, but obviously relatively uh safer or less volatile sector of the stock market, more steady eddy, less a growth play, but utilities have become more, or I think visibly more growth play because of the pure electricity usage that's needed for the AI side of things.

SPEAKER_00 12:15

100%. I would say like amongst defensive utilities definitely stands out with, you know, an above trend growth profile, regulated base rate, regulated base rate growth. And of course, you said all the electrification and power demand and grid expansion uh needed to, you know, support the AI build-out. Um, you know, we've also seen some potential MA in the sector, right? The deal has yet to be approved, but the largest holding next era has entered an agreement to acquire Dominion Energy. So it's a sector that I'm keeping my eyes on. Um and you really, I really think that it can be a nice complement to some of those higher opt-in sectors like technology, consumer discretionary, and communication services.

SPEAKER_01 13:00

A lot

ETF Flows Show Crowding And Hedges

SPEAKER_01 13:01

of people like to focus on the hard data on flows, right? And because obviously State Street is has always been at the forefront of the sector ETF uh uh play, a lot of people to the sector ETF flows from State Street to sort of see like what's the mood of the market, right, in any particular week, month, or over a longer term period. Um talk talk me through a little bit how the flows have looked uh across the various sector ETFs, you know, where where's the where's the demand really picking up? Um, you know, I mentioned from the standpoint of uh you as somebody that's on the ground, but when we look at the hard data, I guess, you know, what what surprises you, what stands out when you look at some of this data flow on the sector ETFs you offer?

SPEAKER_00 13:39

Right. So I would say in terms of flows, there's two things that stand out to me, you know, over the last year. And first is the massive inflows into technology and quite a bit of outflows in the financial sector. Um, you know, let's think about this in terms of investor positioning, right? So I would say, you know, while technology is a, I would say, you know, a crowded trade, I think that's where the strongest earnings are and where the momentum has been and where the flows have been the most consistent, right? So technology leads inflows by an extremely wide margin, which tells us that investors are really comfortable leading into that exposure. But a crowded trade doesn't necessarily mean that it's wrong, right? Tech is crowded for a really good reason. You have an AI narrative that's extremely powerful, you have a capex cycle that is real, and we've already discussed the enthusiasm around earnings in the sector. So what I believe some of the underappreciated opportunity in terms of investor positioning and where the opportunity lies is in the sectors that are set to benefit as the uh benefit from the second-order effects of artificial intelligence. You know, think of sectors like industrials, materials, because that's where you're going to see the equipment, the engineering, construction, and raw materials side of the story unfold. So if you think of the TMT sectors as the obvious AI trade, I'd say that the asset heavy cyclicals are a less crowded way to participate in that same bigger trend. Um, and you know, the flows for technology are just really strong. Something behind um, you know, else that's strong that that stands out to me is industrials. Industrials have taken in over $17 billion of flows over the last year. You know, that that that's quite surprising. That's quite a remarkable number. Also, energy. Energy was in outflows prior to um all of the geopolitical tension that we've seen this year around Venezuela and Iran escalation. And I think that investors are starting to look back at the energy sector as a geopolitical hedge, as an inflation hedge, and as an overall diversifier to their portfolios. You know, in fact, year to date, it's the only sector that has a negative correlation to the SP 500.

unknown 15:39

Yeah.

SPEAKER_01 15:40

Yeah, which I think is is um it's interesting because that's the definition of diversification, right? So we have zero to negative correlation, and it's important for investors to think about constructing a portfolio with those kind of correlation uh dynamics. Um

IPOs And When New Stocks Enter

SPEAKER_01 15:54

a lot of interesting things we've talked on here. Um I am curious to hear your views, your thoughts, uh, you know, and how C3 obviously kind of views um you know the the the again, the sort of difference between sectors versus themes. Themes go in and out of cycle uh favor and and get get kind of out of favor. Um I think there's a there's kind of a movement back into themes, especially the last several uh months here, uh, especially as kind of more of these income plays are out there and and things that from the administration that are coming out, which um are getting people interested in certain types of things. Um one of the themes, obviously, that's out there is space. You know, as we're recording this, it's on the day of the IPO of the SpaceX uh launch, a lot of big interest there. Uh some people think it's gonna moon, some people think it's gonna go come back to Earth. Um, this conversation is more about the sector side of things, but when you when Stage Street sees some of these big things taking place and the excitement around IPOs, uh, how does that actually factor into any of the sector ETF inclusions? Talk us through what causes a stock to get in and out of a particular sector ETF.

SPEAKER_00 16:58

Absolutely. So, you know, our sector ETFs really were the original thematic investments available uh for investors when we launched them in 1998. And really, when we look at the flows and look at the excitement around sectors, sectors are back, right? Sector flows were out of favor for a bit coming out of 2022, where really a lot of the thematic and I would say more sexy offerings uh took hold with investors. But we're starting to see a reversal of that trend as investors look at sectors as core building blocks for their portfolios. Um, you know, as it relates to sectors and industries at State Street, um, you know, when people think about SpaceX, they're thinking rockets, industrials, or AI technology. But as we spoke about under the Giggs framework, it's actually being classified under communication services. And the reason is straightforward because of that satellite broadband business, Starlink, um, you know, responsible for a majority, I think it's over 60% of SpaceX revenue. So the big question is when are sector ETFs that track the SP 500 going to include SpaceX, right? And the answer depends um basically on which index you're tracking. So State Street sector ETFs draw from the SP 500, and the index has not created a fast track mechanism for megacap IPOs like SpaceX, Anthropic, or OpenAI, right? So the current rules really emphasize and require roughly 12 months of trading history, positive cumulative earnings, and sufficient liquidity. That said, industry-level ETFs are a different story because industry ETFs track the SP total market indices and not the SP 500 family. There is a fast track mechanism for adding mega cap names. And SpaceX may show up in telecom industry ETFs as early as September. But to me, this distinction is actually a feature, not a bug. I think that, in my opinion, SP 500 scepters evolve over time with large cap companies that demonstrate financial viability and sufficient liquidity, not just a large IPO or a massive market cap. And I think that that discipline is exactly what investors should want from their core sector building box.

SPEAKER_01 19:09

So

Healthcare, GLP-1s, And A Rebound Case

SPEAKER_01 19:10

I'll tell you that from my perspective, I've I've talked about this a little bit on the lead lager board. Um healthcare is probably, to me, at least the most intriguing sector to consider. And a lot of that's because it's underperformed so badly, right, relative to the broader market. The reasoning, which there is some truth to it, is that um, you know, the the usage of GLP1s, the sort of uh health benefits that come from going from obese to you know normal weight has impacted basically every part of you know the health ecosystem because so much of illness and so much of hospitalizations do come from just being obese, right? And GLPs just seem to be very effective in combating that. Uh, but I think we've also gotten to a point in the healthcare sector where it's almost um uh too much of a story and it's caused undervaluations. I'm curious, uh, from your perspective, uh healthcare as a play, as a sector play, um, is that maybe one of the sleepers?

SPEAKER_00 20:02

Absolutely. So, you know, it's a really one of the most beautiful things about sectors is that there's opportunity across the board across the 11 sectors, right? Including contrarian opportunities for sectors like financials or for healthcare, like we're talking about. You know, in terms of GLP, that's something that we're really watching, particularly the rollout of oral GLP medications. It's something that we're really looking into here at Stage Street and we're watching to see if these companies are able to fully scale those developments. Um, you know, I think that the numbers when you look at data on projections of how many people in America and abroad that are set to be on GLP by 2030 is quite impressive. Um, you know, on that same vein, I think that really, you know, what you need for healthcare to have a rebound is more about restoring earnings confidence and getting investors comfortable with some of the more defensive areas of the market. So I think that you need a combination of more stable fundamentals. You need probably better sentiment around the earnings outlook and really just some broadening and leadership beyond the AI mega complex, right? So if that happens, I think that healthcare becomes a little bit more attractive because it offers a mix of defensiveness and idiosyncratic growth that I think has been really underappreciated in this market. But as long as the bulk of the attention remains tied to um and capital remains tied to AI names, I think that sectors like health there are going to struggle to reclaim leadership, even if fundamentals do improve.

State Street Tools And Sector Outlook

SPEAKER_01 21:27

Yeah, I think that that's very well articulated. Uh, Daniel, for for those um, first of all, let's appreciate the time, but what have we not covered that you think is important for investors to think about when it comes to sector ETF investing, and in particular Stage Street as sort of the leader there?

SPEAKER_00 21:40

You hit the nail on the head that you know that we are the leader in sector investing. And you know, our team has a wealth of knowledge, thought leadership, and resources available to investors. So you can visit our website, sectorspiders.com, um, and you can go to our sector investing homepage where we produce regular commentary. We have tools, we have a sector. Heat map, we have a new correlation tracker, and really um, you know, are focused on putting out the best in-class resources and information on sector investing. Um, you know, one thing I would like to share is our sector market perspectives with the group and really show how we're thinking about each of the 11 sectors over the next six to 12 months. You know, right now, I'd say outside of AI and the technology complex, um, you know, there is opportunity across the board, right, in terms of cyclical and defensive sectors. So we really prefer the sectors that have either a clear investment tailwind or a defensive role that feels really like relevant in today's market, right? So we're really constructive on those pure AI-exposed sectors like communication services and technology, while the global backdrop also supports some of the old economy sectors like energy, materials, and industrials. Um, energy, as earlier stated, plays a really important role in diversification, inflation sensitivity, and the broader infrastructure angle tied to global growth and utilities truly stand out as benefiting from AI-driven power demand and electrification trends. You know, in terms of the sectors that we're a little bit less constructive on, you know, the investors can consider probably an underweight position in those sectors that lack a clear earnings catalyst, that were being sensitive to higher rates, or really just don't have enough evidence of improving investor sentiment just yet. Um, so, you know, for example, when it comes to consumer sectors, both consumer staples and consumer discretionary, our outlook there remains a bit subdued because you have rising inflation, you have decreasing savings, and you have moderating consumption across the board. So we're watching those sectors quite closely for some catalysts that can flip the switch. And when it comes to real estate, that's a sector that's a bit more exposed to financing pressure and rate sensitivity. Um, however, there has been a slight improvement in the flows in recent months and weeks. Similarly, financials really need a more visible rate backdrop and a steadier credit environment for investors to feel more comfortable adding exposure there. You know, overall, I'd say that the key message is not that investors really need to avoid entire areas of the economy or the market, it's that they should be really aware of their sector equity exposure and where they're leading into exposure. You know, there's opportunities across the board beyond technology, including in the defensive and cyclical sectors. And I think that this sensitivity that's top of mind for investors should translate over to their portfolios and they should use ETFs sectors as core building blocks to adjust their portfolios for the given macro conditions.

SPEAKER_01 24:41

Uh yeah, you know, I think uh very interesting things covered here. And again, it's a part of the marketplace, which is important, obviously, and is a big driver, not just from a signaling perspective, but uh potential outperformance perspective when you think about sectors as opposed to individual position plays.

Where To Follow Daniel And Close

SPEAKER_01 24:54

Uh, for those who want to learn more about State Street's offerings and maybe reach out to you or your team, what's the best way to go about doing both those?

SPEAKER_00 25:01

Absolutely. You can find me on LinkedIn, uh Daniel Santiago, or I'm the at ETF influencer across all my other socials. Feel free to send me an email or reach out to me on LinkedIn. We're happy to help engage with investors, help you with your practice, help you with portfolio implementation ideas, and overall just really have conversations with people, spark innovation, spark ideas, and think about sectors that have maybe been forgotten in your portfolio over the last couple of years.

SPEAKER_01 25:28

Uh folks, I'm not saying this because Daniel's on this uh podcast on Lead Light Live, but uh he is one of the good ones in the industry. I've gotten to know him, like I said, over the last several years, has always been uh a friend and somebody who's been uh really, really thoughtful when it comes to thinking about uh how do you position portfolios, and he has that to handle for a reason as the NTF uh influencer and and a go to. So everybody make sure you follow him. Thanks for listening, and uh hopefully we'll see you all on the next episode of Lead Lag Live. Thank you, Daniel. Appreciate it. Thanks, Michael. All right, cheers, everybody.