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3 ETFs to Profit from the Manufacturing Upswing

PRN RGI FXR

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With the broader market picking up steam, capital goods and the manufacturing sector in the U.S. are once again under the spotlight. Lately, the sector came up with the strongest data since 2011.

US Manufacturing Activity on the Upswing

Manufacturing index grew 0.9% sequentially in November 2013 to 57.3% as per the ISM manufacturing index, for the sixth successive month. The month’s PMI reading was the highest almost in two years. The data breezed past the market expectation which called for a slowdown in manufacturing growth.

Out of the 18 manufacturing industries, 15 actually reported growth in November. Industrial production, new orders and employment have all been rising at a solid clip. Higher order backlog, improving exports and slowing supplier deliveries point to an enhanced business environment (read: 3 ETFs for Manufacturing "Renaissance").

Behind This Uptrend

We remain optimistic on the sector as a whole. The financial management and advisory firm – Merrill Lynch – is also supportive of our view and upgraded the sector to Outperform earlier this year.

Let’s dig a little deeper and take a look at the drivers of this trend:

Domestic Economy Remains on Track: The U.S. economy has now come a long way from the meltdown that occurred five years back. All economic indicators are improving, be it housing, job or consumer confidence data, from the pre-crisis level. In a nutshell, improved domestic demand for industrial equipment and better performance by the airline, railroads and shipping companies are leading the space higher.

Reduced Wage Differential & Lower Energy Prices: As per Merrill Lynch, a tapering wage difference between the U.S. and emerging nations, still-low inflation rate and a weaker dollar as compared to its historic level are shoring up the U.S. manufacturing industry (Read: Can U.S. Manufacturing Industries Keep Expanding? ). Lower energy prices are also contributing massively to the sector. Also, the firm expects “business spending to grow 3x faster than consumer spending by early next year”.

Rebound in Europe and China: European revival also contributed to the industrial growth in the U.S. After a rough patch thanks to sovereign debt issues, high unemployment and stagnant growth, the European economy has finally entered into the zone of recovery which led to increased consumption.

The world’s second largest economy – China – is also showing a pickup from a short-term slowdown which in turn bolstered the import profile of the country thus giving optimistic cues to the U.S. manufacturing industry. In short, the Chinese revival is helping in the U.S. export resurgence to some extent.

Market Impact

There are hardly any U.S.-based industrial ETFs which have not returned at least 30% in the year-to-date time frame (as of December 2, 2013). Funds discussed below offer targeted bets on the sector and tapping of these funds can help investors garner profits if confidence in the bloc continues to rise.

Industrials/Producer Durables AlphaDEX Fund (FXR - ETF report)

This fund follows the StrataQuant Industrials Index which is based on the AlphaDEX stock picking methodology. In spite of focusing just on the market cap this technique closely monitors the stocks’ price appreciation/momentum, sales and earnings growth as well as value factors and ranks accordingly.

The ETF has managed assets worth $555.4 million. In total, the product holds 101 securities, which are not at all concentrated on its top 10 holdings. Not a single company accounts for more than 1.89% of the basket. The almost equal-weighted strategy eases out the risk quotient of the fund. Investors have to pay 70 bps in fees and expenses which is higher than the average expenses charged by the industrial equities ETF.  

FXR gained an impressive 40.7% so far this year (as of December 2). The product has a Zacks Rank of 1 or ‘Strong Buy’ rating with a ‘Medium’ risk outlook.

PowerShares Dynamic Industrials (PRN - ETF report)

This ETF tracks the Dynamic Industrials Sector Intellidex Index, giving investors exposure to 60 U.S. industrial companies. The fund holds about 61 securities in its basket with AUM of $117.2 million while charging a slightly higher fee of 65 bps per year from investors.

Like FXR, PRN also includes stocks with higher fundamental growth, compelling valuation, and lower risk factors. Securities shown to possess the greatest capital appreciation potential are selected by the Index.

This product also does not call for concentration risk with one-fourth of the total occupying the top-10 share. The fund added 46.32% so far in 2013. The product has a Zacks ETF Rank of 2 or ‘Buy’ with a ‘Low’ risk outlook.

Guggenheim S&P 500 Equal Weight Industrials ETF (RGI)

Yet another enticing but overlooked option is RGI. The fund seeks to track the performance of the S&P 500 Equal Weight Index Industrials. So far, the fund has amassed as asset base of $67.1 million.  

In terms of performance, RGI is up about 33.0% year to date. Moreover, RGI is the cheapest among the three, charging just 50 basis points a year. It could thus be an interesting choice for those seeking to keep total fees low.

Being an equal-weight product, RGI has a lower ‘risk’ outlook while it carries a Zacks Rank #2 (Buy).

Bottom Line

On the flip side, this bullish data once again renewed the taper concerns due to which the funds might falter in the near term reflecting broader market volatility. The prospect of trimming stimulus will likely boost the dollar which, in turn, will make imports from the U.S. costlier. But we believe that the sector has already priced in such issues and the domestic pent-up demand will be well enough to sustain the momentum.

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