In this recession manufacturing is leading the US out of
recession. The pace is of that recovery, however, is slower than
most business cycles. Major capital expenditures which form the
core of industrials are often triggered by consumer spending, and
right now that is in doubt. Train locomotives are purchased by
businesses, but they typically carry goods destined for
consumers.
"Manufacturing has consistently outperformed the pace of
growth in the general economy during this recovery," said Thomas
Duesterberg, president and CEO of the Manufacturers
Alliance/MAPI, a public policy and economics research
organization in the summer of 2010. This is made easier because
most firms are coming of out a very weak 2009, and many will not
see a return to peak performance of 2007/2008 until 2012.
Surprisingly, confidence in US sales growth is outpacing that
of export growth. PriceWaterhouseCoopers' Q2 2010 Manufacturing
Barometer report of US industrials CEOs found that 58% see the US
economy growing, while only 45% of CEOs see the global economy
growing. Exports nonetheless remain respectable and account for
over 1/3rd of industrials' revenues. With the Federal Reserve and
the Treasury now deliberately devaluing the dollar, US goods are
cheaper for those abroad. Eventually this will unwind and create
a headwind for exports.
Industrials remain vulnerable to the credit crunch, and many
are hoarding cash rather than paying out dividends or buying back
stock. Nonetheless, dividend yields remain respectable in the
2-3% range which makes them an attractive investment compared to
currently low bond yields.
The most popular ETF with industrial in its name, DIAMONDS (
DIA
), is not really a manufacturing play. The ubiquitous Dow Jones
Industrials Index which it follows has shed heavy industry over
its 116-year old history. Less than one-third of DIA remains in
manufacturing firms known for hard goods.
Several less visible
ETFs
follow industrial manufacturing faithfully at low cost. For most
long-term investors the obvious choice is either SPDR Industrial
Select Sector ETF (
XLI
) or Vanguard Industrials ETF (
VIS
), each sporting annual fees under 0.25%. Another option is
iShares Dow Jones U.S. Industrial Sector ETF (NYSEArca:IYJ) at
0.48% annual fees. Returns through Q3 2010 show that these three
true industrials correlate highly with each other but not with
DIA.
Today industrials are increasingly sophisticated manufacturers
such as in aerospace, and activities such as steel production are
now found in the basic materials sector. General Electric is the
#1 holding in most industrials ETFs, with 10% holdings typical.
Single company risk is dampened by GE's holding company strategy
of aggregating unrelated companies. The funds all include names
such as Caterpillar, 3M, Boeing and United Technologies.
Transportation companies such as Union Pacific and United Parcel
Service are lumped in with industrials for their use of heavy
machinery.
There are three fundamental ETFs which attempt to beat the
standard indexes:
- First Trust Industrials AlphaDEX ETF (
FXR
); 0.7% annual fees
- Invesco PowerShares Dynamic Industrials Sector Portfolio
ETF (
PRN
); 0.6% fees
Historical data suggests that weighting with fundamental
financial ratios can beat traditional market capitalization
indexes before fees. Market capitalization is swayed by investor
emotion, and there has been plenty of that in recent years.
Fundamental ratios are a pure reflection of a company's
performance. Unfortunately fundamental ETFs not only have to beat
their benchmark rivals but must do so consistently by about
0.40%-0.50% to offset their higher fees. This is a tall
order.
A more straightforward index variation comes from the Rydex
S&P Equal Weight Industrials ETF (RGI), with 0.5% fees. The
effect of equal weighting is to dampen single company risk (ie.,
improve diversification) and to tilt exposure to smaller
firms.
Claymore/Morningstar Manufacturing Super Sector ETF
(NYSEArca:MZG) goes beyond manufacturing to include energy and
consumer discretionary firms. It might prove convenient to some
investors, but they could easily allocate similarly by picking
multiple industry sector ETFs at less annual expense.
In addition there are international industrials ETFs:
- iShares S&P Global Industrials ETF (NYSEArca:EXI);
annual fees of 0.48%
- SPDR S&P International Industrial Sector ETF (IPN);
0.5% fees
- WisdomTree International Industrial Sector ETF
(NYSEArca:DDI); 0.58% fees
- Emerging Global Shares Dow Jones Emerging Markets
Industrials Titans ETF (NYSEArca:EID); 0.85% fees
Finally, there are two leveraged ETFs, one double long and one
double short. Needless to say they are are highly volatile and
for traders only:
- ProShares Ultra Industrials ETF (UXI); 0.95% annual
fees
- ProShares UltraShort Industrials ETF (SIJ); 0.95%
fees
Co-founder of indexfunds.com, author of two books on
investing, and founder of ETFzone.com, Will has been writing on
indexing issues for 8 years. He holds an MBA from the
University of Texas at Austin.