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Investment Ideas

Earnings season is once again upon us, and this time, it looks to especially drive the market.  That is because China and Europe are clearly in a muddle through phase, while our next politically-induced crisis, the debt ceiling debate, is still about a month away, suggesting that earnings will be the focus for the next few weeks.

Unfortunately, expectations for this earnings season aren’t exactly great. Financials, which were the star in the previous season, are on shaky footing, while the latest news from tech giant Apple (AAPL - Analyst Report) looks to rile the broader tech outlook as well.

That isn’t to say that every sector is looking to have a down or underwhelming release though, as there are at least a few segments which could be poised to have a great earnings season to start 2013. One can easily find these primed sectors, and broad ETFs tracking them, by utilizing a combination of the Zacks Industry Rank along with the new Zacks ETF Rank (read 4 Best ETF Strategies for 2013).

This process should result in finding a few ETFs which are tracking strong sectors that are highly ranked, and hopefully poised to see strong earnings this month as well. With this technique, the following three ETFs could be great picks for this earnings season, thanks to strong momentum and favorable analyst estimate trends that all three look to continue as more profit reports start trickling in:

SPDR S&P Homebuilders ETF (XHB - ETF report)

The building and construction space was among the best performers in 2012. However, XHB trailed its counterpart (ITB - ETF report) for much of the year, thanks to its bigger focus on ‘auxiliary’ home construction plays like furnishings and home improvement stores.

While the sector does look to continue moving higher, we could see a shift towards these other plays in the space, as they have not seen as much of a run-up as of late, and the home furnishing sector is one of the top Ranked industries. If that wasn’t enough, XHB recently moved up from a Zacks ETF Rank of 3 or ‘Hold’ to a Rank of 2 or ‘Buy’, suggesting now might be the time for this ETF.

The fund holds 37 stocks in its basket, with homebuilding accounting for about 30% of assets, followed by building products and then home furnishings. Even though it might seem somewhat concentrated at first glance, XHB also does a great job of spreading out assets, allocating less than 3.75% to any one security (read Is XHB a Better Housing ETF Play?).

The product also charges a low expense ratio of 35 basis points a year, while its volume and total assets under management are quite impressive so total costs look to be low. Investors should also note though, that the product has seen a tremendous increase in price over the past year, so it isn’t likely to be much of a value pick.

PowerShares Dynamic Leisure and Entertainment Portfolio (PEJ - ETF report)

This ETF focuses in on firms in the broad leisure and entertainment space, zeroing in on media, restaurants, and hotels, among others. Currently, media, leisure services, and publishing are among the top Ranked industries, so it could be a great quarter for these companies, and by extension, PEJ as well.

However, investors should note that the product has just a Zacks ETF Rank of 3 or ‘Hold’ thanks to its lower volume levels and relatively high expense ratio. Still, the product seems well poised to take advantage of some shorter term earnings momentum and be a strong pick for ETF investors at this time (see 3 Overlooked Ways to Target Consumers with ETFs).

In terms of the portfolio, PEJ holds just 30 stocks, but does a great job of spreading out assets; no one firm accounts for more than 5.5% of the total. There is also a big chunk in small caps, so volatility could be elevated (which is why we have a ‘High’ risk rating on the fund).

Expenses do come in rather high considering everything though, as the net cost is at 63 basis points a year, while volume can be light. The fund has easily beaten out the S&P 500 as of late even with these downsides, and if some of the companies can see earnings results as impressive as their underlying Zacks Ranks, this could be another solid quarter for the fund.

First Trust Health Care AlphaDEX ETF (FXH - ETF report)

The health care sector has quietly had a great year, led by strong performances from major drug companies in both the broad pharma space, and in the biotech industry. This could continue here in 2013, as drugs are currently ranked in the top 20%, while medical products and insurance are also in the top half of Zacks Ranked industries.

Investors can get broad exposure to this trend with FXH, an ETF that is currently sporting a Zacks ETF Rank of 2 or ‘Buy’, along with a Low risk rating. The ETF not only offers up holdings in many of the segments highlighted above, but it utilizes the AlphaDEX methodology which could be a more quantitative approach to health care ETF investing (see Zacks Top Ranked Healthcare ETF: FXH).

With this process, First Trust finds only the most favorable stocks in the segment and gives higher weights to those securities that have impressive valuation or growth metrics. The company also eliminates the bottom 25%, so in theory only the best stocks are taken into the ETF.

This results in an ETF that has a heavy focus on health care providers, and then a big focus on equipment firms as well. FXH is also extremely spread out, but investors do have to pay a bit for this more involved methodology as this ETF costs investors 70 basis points a year in fees, though it does have solid levels of volume.

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