ETF Investing: Top 5 Sectors For Last Stretch Of 2013

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Some of the headlines say September could be the worst ever for the stock market  given all of the uncertainties springing from Syria, the Federal Reserve and congressional budget debates.

We asked ETF investing strategists to share their best investments idea for the final stretch of the year.

1. Reed Eckhout, market analyst at CitrinGroup in Birmingham, Minn., with $60 million in assets under management: PowerShares KBW Bank Portfolio ETF ( KBWB ).


Expectation that the Federal Reserve will reduce Treasury and MBS (mortgage-backed securities) purchases have produced volatility -- especially in interest rates across the globe and the U.S. Historically, an environment of increasing interest rates coincides with poor performance in fixed income and a difficult environment for equities because corporations have to pay higher rates on newly issued debt.

However, unlike most corporations, banks tend to perform well in a rising rate environment. They borrow at low, short-term rates and lend at higher, long-term rates. And as interest rates rise, their profits increase from the widening spread. The Federal Reserve has stated that the discount rate will remain near zero until unemployment and inflation targets are met, which may not be until around 2015.

Even though financials have had a solid rally this year, they are still in the early innings of their full potential performance. U.S. financials just finished the second-quarter earnings season with 79% of companies beating expectations -- the highest rate among all sectors. They also enjoy the best earnings growth rate, 28%, among all sectors. Financials are trading at 12 times forward earnings estimates, while the S&P 500 trades at 14.1 times.

Additionally, they're benefiting from improving credit conditions, improving gross loan growth and near-record capital ratios. Investment risks include exposure to Europe, new reforms or regulation and lawsuits.

KBWB is a concentrated, 24-company bank ETF that provides exposure to large and midcap value and growth stocks. It is based on the KBW Bank Index and is a float-adjusted, capitalization-weighted index. The ETF is comprised of the leading national money center banks and regional thrifts. Its top five holdings areCitigroup ( C ),JPMorgan Chase ( JPM ),Wells Fargo ( WFC ),Bank of America ( BAC ), andSunTrust Banks (STI).

2. Neena Mishra, Research Director at Zacks Investment Research in Chicago:Industrial Select Sector SPDR (XLI).

U.S. manufacturing activity has been quite upbeat of late, as manufacturers have been expanding production and adding jobs in response to the increased demand.

Many believe that the country is on the verge of a manufacturing "renaissance," thanks mainly to lower energy prices, improving technology and rising labor costs in developing economies. Critics, on the other hand, point out that the manufacturing output in the country is still much lower than the beginning of the recession.

According to a recent report from the Boston Consulting Group, the U.S. is fast becoming one of the lowest-cost countries for manufacturing in the developed world. Per BCG, average production costs in Germany, Japan, France, Italy and the U.K. will be 8% to 18% higher than those in the U.S. by 2015.

While there may be disagreements as to whether the rebound in manufacturing seen since 2010 is just a cyclical recovery or a structural turnaround, there is no doubt that the recent manufacturing data in the U.S. as well as in Europe and China, suggests a strong uptrend.

The manufacturing sector has benefited from the housing market recovery, which has resulted in increased demand for furniture, appliances and wood products. Rising consumer confidence and a healing labor market have also boosted the demand for manufactured products.

These factors in turn have been able to offset the headwinds generated by slow global economic activity and effects of the sequester. Per Zacks estimates, industrials sector earnings will grow by 12.0% in 2014, sharply up from just 1.3% in 2013.

XLI currently holds 63 stocks, mostly large and liquid companies.GE (GE) is the largest holding, weighted at 11.5% of assets.

In terms of sector exposure, aerospace and defense (26%), industrial conglomerates (19%) and machinery (19%) take the top three slots. Most aerospace and defense companies reported excellent results for the second quarter, defying sequester woes. Rising geopolitical risks may further support defense stocks.

On the flip side, if the U.S. economic growth falters in the coming months, due to rising interest rates or the looming budget battle, industrial stocks may be affected. Also, this sector in general is more volatile than the broader market.

3. Doug Fabian, president of Fabian Wealth Strategies in Costa Mesa, Calif., with $100 million under management:PowerShares CEF Income Portfolio (PCEF).

Most investors are fleeing fixed income in droves. Fear of further rate rises once the Fed announces its plans for bond purchases is everywhere. Its time to be a contrarian as the peak in rates may be this month.

PCEF is comprised of 146 income-producing closed-end funds. It has an enticing yield of 7.7%, generated from its investments in a combination of high-yield, investment-grade, fixed-income and equity-option income strategies. What makes this fund so compelling at this time are three factors.

1) We have had a huge move up in yields, causing the value of bonds funds to decline. PCEF has been no exception as its prices has fallen over 9%, but we believe that the highs in yields could be reached after the announcement of the Fed plans. Once there is more clarity, yields will most likely go sideways or down into year-end.

2) Closed-end funds trade at premiums and discounts to their net asset values. Such is the case of the underlying securities in PCEF. Right now the discounts within the fund are near historical highs, above 7%, while the historical average discount is 4%.

3) Sentiment in the bond arena is extremely negative, with retail investors selling bond funds en mass. In our experience, retail investors panic near the end of a big move. So now is the time to be thinking about buying income assets.

One-third of the assets in PCEF are dedicated to generating income via equity-option strategies. This component should perform well in the traditionally strong year-end rally.

PCEF is an excellent tool for yield and total return in a stable or declining-rate environment. It will provide investors with a monthly income stream as well as price appreciation, even if rates go sideways because the closed-end funds in the portfolio are trading at a discount to their net asset value.

If we see heightened concerns for economic growth globally or a risk event in the Middle East, rates will fall not rise from these levels. It's time to think outside the box and purchase this fund after the Fed meeting on Sept. 18th. We do expect this fund to fall further ahead of the Fed meeting.

4. Scott Martindale, senior vice president of Sabrient Systems in Santa Barbara, Calif.: First Trust NASDAQ Technology Dividend Fund (TDIV).

TDIV holds 79 technology and telecom companies that pay a common dividend, and weights those stocks based on dividend contribution rather than market cap. So, whereasGoogle (GOOG) is the third-largest holding in iShares Dow Jones U.S. Technology (IYW), it is not even a constituent of TDIV because it doesn't pay a dividend. Also, whereasApple (AAPL) is by far the dominant holding in IYW with an 18% weighting, TDIV holds approximately equal weights (7%-9% range) in Apple,Cisco (CSCO),Microsoft (MSFT),Intel (INTC) andIBM (IBM).

Stocks in TDIV display a relatively low forward P/E (price-earnings ratio), a solid long-term projected growth rate and impressive return ratios. Also, Wall Street analysts have begun to show enhanced support in the form of positive net revisions to earnings estimates. In fact, many analysts are predicting that the lagging performance of the technology sector makes it poised to lead the next leg of a market rally. Overall, TDIV scores a robust 99 (out of 100) in Sabrient's Outlook Rank.

Although TDIV has demonstrated a propensity to hold up relatively well during periods of market weakness, if the market takes a nasty downturn, TDIV is not likely to hold up as well as a traditionally defensive sector like consumer staples, or a fund that pays high dividends, like theAlerian MLP ETF (AMLP).

5. Vern Sumnicht, CEO of iSectors, in Appleton, Wis., with $145 million in assets under management: SPDR S&P 500Dividend ETF (SDY) andFirst Trust Value Line Dividend ETF (FVD).

Unless Congress cuts spending, government debt will continue to increase. This means the Federal Reserve will need to keep printing money. Since 2009 the Fed has been buying more than half of this debt. Talk of tapering will only raise interest rates, it won't stop the Fed's printing. Therefore, the biggest risk for investors over the long-term is inflation and rising interest rates.

However, this means opportunities in the short-term. Where will all this printed money go? Bonds are too overvalued and who wants to borrow government money for 30 years and get 3.5%?

Then where can billions of dollars get liquidity, safety and close to 3% dividends? Domestic large-cap value stock funds such as SDY and FVD, which both focus on strong consistent dividend-paying equities.

Both of the dividend ETFs here are core positions within iSectors Domestic Equity Allocation, a strategic portfolio of diversified domestic equity ETFs. The iSectors Domestic Equity Allocation currently overweights large-cap dividend-focused ETFs.

In addition, we see the Fed continuing to be accommodative and the easy-money policies will continue to drive investor demand to put money to use in equities.

Follow Trang Ho on Twitter @IBD_THO .



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: BAC , C , JPM , STI , WFC

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