Vanguard, the Valley Forge, Pa.-based mutual fund and ETF giant,
is cautiously optimistic about the prospects for a U.S. economic
recovery in 2011, though the firm acknowledges its new outlook
falls between gloomier or rosier forecasts.
Nevertheless, Vanguard, using its suite of proprietary leading
economic indicators, predicted this week that the all-important
U.S. labor market will regain some lost ground this year.
"Our analysis suggests that-for the first time in five years-the
balance of risks to the U.S. outlook is now tilted toward
better-than-expected job growth," Joseph Davis, Vanguard's chief
economist, wrote in the report.
According to Vanguard's research, the most promising indicators
relate to manufacturing, corporate cash flows, expected business
spending, and certain sectors of the labor and financial markets.
Conversely, indicators relating to construction, overall
confidence, consumption and credit are the most pessimistic.
That sort of outlook would augur well for sector funds such as
the Financial Select SPDR ETF (NYSEArca:XLF) but perhaps less so
for the SPDR S&P Retail ETF (NYSEArca:XRT). XLF rose about 10
percent last year, while XRT has risen about 30 percent in the past
If U.S. growth materializes without further intervention by the
Federal Reserve or congressional lawmakers-what economists call a
self-sustaining recovery-then Vanguard expects stocks to continue
their current rally.
But even modest growth has its attendant risks-including rising
interest rates and inflation-and the report cautions investors to
focus on strategic asset allocation in 2011 rather than tactical
opportunities during what Vanguard believes will be a volatile
"We're trying to treat the future with the humility it
deserves," Davis said in a telephone interview, acknowledging the
difficulties of forecasting.
Vanguard's Track Record
So how do Vanguard's past predictions match up with history?
Looking at the performance of some sector ETFs provides some
Using a suite of proprietary measures of the business cycle that
it calls the Vanguard Economic Momentum Index (VEMI), the firm
predicted this week that the U.S. labor market will regain some
lost ground this year. Analysts agree that a strong job market is
the linchpin that will indicate the economy is meaningfully on the
That call was right. State Street's Industrials Select Sector
SPDR (NYSEArca:XLI), a heavily traded measure of the U.S.
manufacturing sector, finished 2010 up more than 23 percent over
its share price at the start of the year.
Other industrial sector ETFs, including the PowerShares Dynamic
Industrials Sector Portfolio (NYSEArca:PRN), also fared well last
Similarly, the financial sector performed well in 2010, in
accordance with Vanguard's outlook. As mentioned above, XLF, the
financial sector fund, gained more than 10 percent in 2010,
although the fund was volatile. For example, at the end of the
third quarter, the fund was down 7 percent.
Vanguard's VEMI takes into account 70 separate leading
indicators. The firm also uses what it calls the Vanguard Economic
Dashboard, a graphical depiction of those 70 sectors. Both tools
are calibrated using payroll growth to gauge the strength of the
According to Davis, Vanguard's 70 leading indicators run the
gamut from consumer behavior to stock market performance and
include information as varied as the steepness of the yield curve,
sentiment surveys at restaurants, Google keyword searches by job
seekers and cardboard orders by manufacturers.
Where we believe we add value is that we calibrate these data to
the second derivative, which means we're looking at changes in
momentum in these indicators," Davis told IndexUniverse.com.
Vanguard also introduced a new tool in its 2011 report:the
Vanguard Leading Economic Index (VLEI), which is also linked to
growth in U.S. employment. According to Vanguard, the VLEI has
historically led payroll growth in the various sectors by about
By its own admission, Vanguard's 2011 forecast doesn't take into
account two of the most depressed sectors of the U.S.
economy:commercial real estate, and state and local
"Those sectors have lagged the business cycle," said Davis. "If
state and local governments or commercial real estate become a risk
to the outlook, then that should start affecting the other leading
indicators in the VEMI before it affects job growth."
Don't forget to check IndexUniverse.com's ETF Data
2011 Index Publications LLC
. All Rights Reserved.