3 Cyclical ETFs to Buy in a Rebounding U.S. Economy - ETF News And Commentary

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Signs of recovery in the U.S. economy, though not brisk, are surely more than what we saw early this year. Spring sprung more jobs, better housing data, strong manufacturing numbers and confidence in the country among its citizens. A steady QE wrap up also gave hints of economic well being. An influence on the stock market was only natural. 

Overseas too, things started shaping up. Though Iraq poses a new tension and Russia concerns show no signs of cooling off, the second largest economy in the world, China, has shown stability, European Central Bank cut the bank deposit rate to the negative territory and Japanese economy picked up, giving much-needed warmth to the frozen U.S. economy.

Most sectors benefited from the stock market surge, with a few of the more cyclical corners making the most of this run-up. These industries often sag in a slumping economy, but are the biggest winners when rays of hope are seen.

Even though broad corporate earnings in Q1 caused some concerns thanks to feeble growth and persistent downbeat guidance, three cyclical sectors discussed below can deliver better returns this year and in the next.  

Zacks Sectors 2Q14E 3Q14E 2014E 2015E
Consumer Discretionary 3.4% 5.6% 13.6% 13.8%
Construction 8.3% 13.6% 10.6% 25.8%
Industrial Products 0.5% 3.5% 7.9% 12.4%
(Source: Zacks Earnings Trend )

Many aggressive stocks were shattered in early 2014 due to high-beta pain and risk-off trade sentiments prevailing in the market increasing the appeal for defensive plays. As a result, investors can put their money into this once beaten-down corner of the market pinning hopes on favorable fundamentals and reasonable valuations.

Below, we have highlighted a few possible choices in this space, any of which could be interesting for those seeking a cyclical play at this time:

PowerShares Dynamic Building & Construction ( PKB )

Recent data on construction spending and other metrics such as housing starts were favorable. Service providers, including construction companies and retailers, grew in May at their fastest speed in nine months. A low interest rate environment also played its role in lifting the sector (read: Has Spring Finally Sprung for Housing ETFs? ).

This trend can best be tracked by PKB. This 30-stock ETF has its assets invested across all classes of the market spectrum. Engineering and construction stocks comprise more than one-fourth of the fund, followed by construction material companies which account for 11%. A look at the style pattern reveals that the fund has a preference for value stocks.

PKB manages an asset base of $126.1 million and has an expense ratio of 63 basis points. The fund carries a Zacks ETF Rank #3 (Hold) with a High level of risk. PKB was up 4.12% in the last one month (as of June 10, 2014).

Consumer Discretionary Select Sector SPDR Fund ( XLY )

Spending on consumer discretionary is the first to drop when the economy is slipping. So, it can be considered a barometer of rising income levels of consumers and an improving sentiment in the economy. U.S. consumer confidence which slipped in April rebounded in May.

XLY is by far the largest product in the consumer discretionary space with more than $5.40 billion of assets. In its 88-stock portfolio, Walt Disney (6.68%), Comcast (6.62%) and Amazon (5.84%) take top three spots (read: Will Disney Earnings Spell Magic for Consumer ETFs? ).  

The ETF charges a meager 16 bps in fees a year. The fund gained 4.65% in the last one month (as of June 10, 2014). XLY has a Zacks ETF Rank #3 with a Medium risk outlook.

Industrials/Producer Durables AlphaDEX Fund ( FXR )

An industrial boom is apparent in the U.S. economy due to the narrowing wage differential between developed and emerging economies, strengthening of the U.S. dollar against a basket of emerging currencies and relatively low energy prices in the U.S.  Low borrowing costs and increased availability of bank financing are also shoring up the sector.

While there are several industrial ETFs to play the boom, FXR could be a wise bet owing to its unique stock selection technique. This fund follows the StrataQuant Industrials Index which is based on the AlphaDEX stock picking methodology.

Instead of focusing solely on market cap, this technique closely monitors the stocks' price appreciation/momentum, sales and earnings growth as well as value factors and ranks (see all industrial ETFs here).

The ETF has managed assets worth $1.22 billion. In total, the product holds 102 securities, which are not at all concentrated on its top 10 holdings. The strategy eases out the risk quotient of the fund. Investors have to pay 70 bps in fees and expenses which is higher than the average expenses charged by the industrial equities ETF.  

FXR has added 5.15% in the last one month. The product has a Zacks ETF Rank of 1 or 'Strong Buy' rating with a 'Medium' risk outlook (read: Manufacturing Boom Will Benefit These 3 Industrial ETFs ).

Is There Any Reason to Be Worried?

Having said that, we would like to point out that though the indexes are hitting highs, participation in the stock market is quite low, unlike last year's bull phase. Per Bloomberg , the average daily volume of the S&P 500 companies was the six-year low last month, at about 1.8 billion shares. If this was not enough, only 20 out of 500 companies made it to a 52-week high on May 23 when the index hit an all-time high last month.

Also, World Bank recently reduced global growth projections for this year. Growth for the U.S. was reduced to 2.1% from 2.8% while IMF slashed its forecast for 2014 from 2.8% to 2.0%. New conflict in Iraq though not likely to push the U.S. economy out of track, will definitely weigh on its recovery.

This suggests that investors still care for volatility. Skepticism over valuation still rules the landscape though.  The current S&P 500 PE Ratio stands at 19.34 as of June 16 which is still a bit higher than the mean P/E of 15.51. With the U.S. economy way behind its pre-crisis level, we have to wonder whether this bull run will continue long (read: Volatility ETFs Crash Signaling Further Volatility? ).

Conclusion

Still, we believe investors can take part in the slowing rebounding economy through the afore-mentioned ETFs as these are solely based on earnings estimate trend, especially considering that the trio has so far retuned better than the SPDR S&P 500 ETF ( SPY ). But it is always better to be hawk-eyed before investing in such a ballooning market; you never know when it bursts. 

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PWRSH-DYN BLDG (PKB): ETF Research Reports

SPDR-CONS DISCR (XLY): ETF Research Reports

FT-INDL/PROD (FXR): ETF Research Reports

SPDR-SP 500 TR (SPY): ETF Research Reports

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: PKB , XLY , FXR , SPY

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