The Fed finally decided to reduce its monthly bond purchases by $10 billion and the stock market reacted positively to the news as the move was made “in the light of improvement in the economic activity and labor marker conditions”.
There is no doubt that the QE has been a major force behind the market’s rally this year but the start of tapering signals that the economy is now strong enough to withstand the gradual withdrawal of the QE support. This morning’s revision to third quarter GDP adds to evidence that the economy is on a firmer footing now.
A healing labor market, improving housing market, lower energy prices and still accommodative monetary policy are expected to act as tailwinds for the market, while fiscal uncertainty continues to pose some headwinds. (Read: Obamacare will be amazing for these stocks and ETFs)
US stocks had an excellent performance during 2013. I expect 2014 to be another good year for stocks though it will probably not be as spectacular as this year. At current levels, stocks are not cheap but they are not too expensive either.
Also, corporate earnings will grow as the economy improves further. Many US companies are sitting on large cash piles, and are likely to increase capital spending and hiring as economy grows. (Read: 4 Best New ETFs of 2013)
A gradual rise in interest rates will be good for stocks and bad for fixed income assets in general. But some sectors will do better than others. Industrials, technology and insurance are among the sectors that do well when the economy grows and on the other hand, interest rate sensitive sectors will be hurt.
Below are three excellent ETFs that will benefit from the improving growth/ increasing interest rate environment and will likely be excellent performers in 2014.
Vanguard Information Technology ETF (VGT - ETF report)
The broader Technology sector has been a laggard this year, but with brightening economic growth, businesses are likely to spend a lot more on technology products and services going forward. However, not all industries within the Tech sector will see improvement in growth. (Read: 3 Apple Focused ETFs to buy this holiday season)
Per Zacks Earnings Trends, Tech sector’s earnings growth started picking up in Q3, with Software and Semiconductors industries accounting for most of the growth improvement. IT sector is expected to report the highest revenue growth for Q4, led by 16.0% increase in revenue growth for Internet Software &Services Industry, according to FactSet.
Ongoing trends suggest that cloud computing, mobile computing, data processing and semiconductors segments will likely see strong growth next year.
VGT is one of the most popular choices in the technology space with AUM of $4.4 billion and a low expense ratio of 14 basis points. It holds 428 technology stocks, but about 55% of assets are invested in top ten holdings. However, the product is well diversified among the industries with Internet Software& Services (16%) having the largest exposure. The fund also has a double digit allocation to fast growing Systems Software and Semiconductors industries.
Apple (AAPL) is the top holding with about 14% of the asset base, followed by Microsoft and Google.
VGT is a Zacks Rank #1 (Strong Buy) ETF.
SPDR S&P Insurance ETF (KIE - ETF report)
Improving economic picture is positive for all insurers as their business volume is highly correlated to the health of the economy. Property & Casualty insurers in particular have seen a strong top-line growth this year—a trend that continues to gain momentum.
Insurers also stand to benefit from the rising rate scenario. Many insurance companies—life insurance companies in particular—invest in longer-duration bonds and will earn higher returns on their investment portfolio as rates go up. Though the value of long duration bonds in insurers’ portfolio goes down as rates go up, insurers have very long-term investment horizons and they can hold investments till maturity and no losses are actually realized.
Insurance industry looks very well poised to outperform in the coming months from the Zacks M industry rank (10 out of 62 as of December 20, 2013) perspective too.
KIE follows the S&P Insurance Select Industry Index, which is an equal weight index. The product charges a reasonable 35 basis points per year in fees. It currently pays out a decent dividend of 1.75%.
In terms of holdings, about 39% of the assets are invested in property and casualty insurance sector, while life & health account for another 21% of the asset base. Due to the equal weight methodology, no one security accounts for more than 2.4% of assets.
KIE is a Zacks Rank # 2 (Buy) ETF.
PowerShares Dynamic Industrials Sector Portfolio (PRN - ETF report)
US manufacturing activity has been quite upbeat of late. With lower energy prices, improving technology and rising labor costs in the developing world, the outlook for manufacturing looks quite positive from longer term perspective as well. (Read: Play Surging US manufacturing with these ETFs)
Industrials sector is expected to have second highest earnings growth (14.2%) in Q4, with growth predicted to be broad-based across the sector, per FactSet.
PRN tracks the Dynamic Industrials Sector Intellidex Index, which evaluates stocks using a proprietary investment methodology based on 25 factors that measure company fundamentals, stock valuation, timeliness and risk.
The product has an asset base of $119 million, invested in of 60 industrial companies. It provides exposure to almost all segments of the industrial sector with double-digit allocation to Aerospace & Defense, Machinery, Airlines and Commercial Services & Supplies.
The product is a bit expensive with an expense ratio of 65 basis points annually but it has been beating the most popular industrial ETF. It has returned 47% year-to-date compared with 37% for the Industrial SPDR ETF.
PRN is a Zacks Rank # 2 (Buy) ETF.
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