Do you want to beat the market? Most investors believe owning individual stocks is the only means of doing so. But there are other, safer ways to outperform market-based index funds like the SPDR S&P 500 ETF Trust (SPY +0.80%). Different indexes lead and lag stocks as a whole every year. The key is simply figuring out which areas of the market are positioned to outpace the broad market in the foreseeable future.
With that as the backdrop, here's a closer look at four exchange-traded funds (ETFs) I suspect are poised to beat the S&P 500 in 2023. Note that in a couple of cases, much of this year's likely strength is rooted in last year's relative underperformance.
1. Vanguard Information Technology ETF
Last year was a bad one for most stocks, but it was a downright lousy one for tech stocks. The Vanguard Information Technology ETF (VGT +2.71%) tumbled to the tune of 30% in 2022, largely on fears of the unknown. Technology stocks tend to be highly sensitive to economic weakness, after all. Investors were just thinking defensively in front of what could have turned into a major meltdown.
NYSEMKT: VGT
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In retrospect, though, the sellers overshot their target. Standard & Poor's estimates the S&P 500's technology names still inched their way to a record collective profit last year, en route to yet another record earnings this year.
The index's technology stocks are also priced below their historical average price/earnings ratio -- something levelheaded thinkers are realizing now that some time has passed and inflation is starting to cool. Things just aren't likely to devolve into the worst-case scenario that's been priced in.
2. Invesco S&P 500 Pure Value ETF
While the technology sector may be in a unique position to outperform the broad market this year, that's not necessarily the case for other growth sectors. This year may well be when we start seeing value stocks start dishing out the bigger gains, boding well for the Invesco S&P 500 Pure Value ETF (RPV +0.47%).
The key is interest rates. Growth stocks do particularly well when interest rates are low, since these companies can generally do a lot with lost-cost funding. Growth stocks tend to struggle, however, in a high-rate environment when capital costs aren't so cheap. Conversely, most value stocks do about as well when rates are high as they do when they're low, since lower-cost capital doesn't mean as much to these companies.
Well, in the wake of several hikes of the federal funds rate since early last year, interest rates stand at 15-year highs and are still rising. Not only are growth stocks set to struggle for the foreseeable future, but investors just might start pricing value stocks at premiums above their recent averages.
3. iShares MSCI China ETF
China's economy suffered doubly in 2022. Not only did soaring inflation and global economic weakness adversely impact its once-great growth, but Beijing's so-called "zero-COVID" policies translated into lockdowns that further stymied its overall economy. Last year's GDP growth of 3% was one of the lowest growth rates the country's seen since the 1970s, in fact.
Given this, it's no surprise the iShares MSCI China ETF (MCHI 0.02%) lost 24% of its value in 2022. That setback follows 2021's 22% sell-off rooted in the same reasons.
NASDAQ: MCHI
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The worst, however, may be in the rearview mirror. That's because China finally eased up on its pandemic policies that made it tough to do consumer-oriented commerce within the country. In addition, the end to the draconian lockdown measures also makes it easier for the nation's industries to ease their way back to pre-pandemic norms.
With a newfound economic tailwind in place, a Bloomberg poll of economists suggests China's economic growth rate is likely to reaccelerate to 5.1% this year. That's not a major change in absolute mathematical terms. When you're talking about a country's GDP, though, it's a huge improvement that could easily push a country-based fund like the iShares MSCI China ETF sharply higher.
4. SPDR S&P 400 Midcap ETF Trust
Finally, I'm adding the SPDR S&P 400 Midcap ETF Trust (MDY +0.43%) to my list of index funds I suspect will beat the broad market in 2023. This isn't a call for a rebound from a sharp sell-off, although mid caps did lose plenty of value last year. Rather, it's more of a philosophical expectation. See, mid-cap stocks typically outperform large caps -- in the long run, anyway -- and the next few years aren't apt to be an exception to this norm.
Indeed, the foreseeable future could be markedly different than the recent past, when large caps performed inordinately well. Research outfit Schroders explains: "The goods economy remained robust during the COVID-19 pandemic, while the services economy remained closed. Smaller company earnings are much more geared to services, which should further fuel favorable relative earnings growth."
But that's not the only edge mid caps enjoy right now. Schroders adds: "Smaller companies have not been so cheap relative to large caps since the technology bubble in 1999-2001. In the seven-year period following the market peak in March 2000, small caps were up by more than 70%, whereas large caps were up by less than 10%."
The big takeaway, according to Schroders? "The last time relative valuations were this cheap, and sentiment so poor, was followed by an outstanding period of absolute and relative returns for small- and mid-cap equities."
Take the hint.
