Vanguard: US Poised For Growth In 2011

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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 year.

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 year.

"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 insight.

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 mend.

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 year.

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.

Methodology

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 U.S. economy.

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 four months.

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 governments.

"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 section.

Copyright ® 2011 Index Publications LLC . All Rights Reserved.



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: PRN , XLF , XLI , XRT

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