Warren Buffett recommends low-cost index funds for most people — but BofA says the S&P 500 is the ‘worst thing to hold’ right now. Buy these 4 top sectors to avoid confusion

Warren Buffett likes index funds — particularly those that follow the S&P 500.

“In my view, for most people, the best thing is to do is owning the S&P 500 index fund,” he once said.

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But that strategy may not be optimal in the current market environment according to Bank of America’s head of U.S. equity and quantitative strategy Savita Subramanian.

“The worst thing to hold is the S&P 500 wholesale,” she tells CNBC.

Although following the benchmark index has worked well over the past decade, Subramanian points out that the current environment is different.

“The S&P 500 right now is expensive — it’s super crowded. It’s the most crowded ticker in the world if you think about it from an index perspective.”

She still likes Buffett’s approach for the long-term. But adds that investors have different time horizons.

“If you’ve got a 10-year time horizon, hold the S&P 500 and watch and wait,” she recommends. “But if you’re thinking about what’s going to happen between now and let’s say the next 12 months, I don’t think the bottom is in.”

Of course, that doesn’t mean you should completely bail on stocks. Here’s a look at what Subramanian still likes in today’s market.

Small caps

While Subramanian doesn’t find the large cap-focused S&P 500 attractive at the moment, she sees opportunity in the small-cap space.

“If you think about the small-cap benchmark, it is pricing in a hard landing, deep, deep recession,” she says.

“We think they’re going to be okay. We think we’re going to get a recession, but it’s going to be a softer landing.”

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Investors can use ETFs to get exposure to small-cap companies. Funds like the Vanguard S&P Small-Cap 600 ETF (VIOO) and the iShares Russell 2000 ETF (IWM) could provide a good starting point for further research.

Energy

Subramanian has long been bullish on energy.

“I would look for sectors that benefit from a still-very high inflationary backdrop. I would buy energy,” she says.

While rampant inflation has cast a giant shadow over the stock market, energy stocks have been firing on all cylinders.

In fact, energy was the S&P 500’s best-performing sector in 2021, returning a total of 53% vs the index’s 27% return. And that momentum has carried into 2022.

Year to date, the Energy Select Sector SPDR Fund (XLE) is up a solid 35%, in stark contrast to the broad market’s double-digit decline.

‘Select industrials’

Unlike energy, the industrial sector hasn’t been a market favorite. But Subramanian sees a revival on the horizon.

“I would buy select industrials that could benefit from a CAPEX cycle that we are seeing underway,” she says. “Everybody’s moving companies back to the U.S., it’s going to benefit the traditional industrial companies from a more traditional CAPEX cycle rather than spending on tech.”

To be sure, Subramanian is talking about “select industrials.”

So how do you choose? The key lies in automation.

“I think the best place to be within the industrial complex are some of the automation plays because if you think about it, that’s where companies are spending money.”

Subramanian explains that inflation is happening in the labor market as well.

Therefore, as companies bring jobs back to the U.S., they are “incented to automate more of the processes” compared to when they could just “offshore and pay for super cheap labor” in other countries.

Healthcare

Healthcare serves as a classic example of a defensive sector thanks to its lack of correlation with the ups and downs of the economy.

At the same time, the sector offers plenty of long-term growth potential due to favorable demographic tailwinds — particularly an aging population — and plenty of innovation.

Subramanian finds the sector attractive.

“I think healthcare looks great, it’s got a lot of free cash flow yield,” she says.

Average investors might find it difficult to pick out specific healthcare stocks. But healthcare ETFs can provide a diversified way to gain exposure to the space.

Vanguard Health Care ETF (VHT) gives investors broad exposure to the healthcare sector.

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This article provides information only and should not be construed as advice. It is provided without warranty of any kind.