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3 Hot Sector ETFs Surging to #1 Ranks

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The weather isn’t the only thing that is scorching this month, with the S&P 500 and the Dow Jones Industrial Average seeing red hot performances as well. In fact, both benchmarks have rebounded nicely following the end of the initial Fed tapering panic and are at fresh all-time highs heading into the heart of earnings season.

 In this type of environment, a look to cyclical, U.S-focused sectors could be ideal. These segments will likely be protected from the worst of the current global malaise, while these sectors are usually leading markets during bullish upswings, such as the one we are currently experiencing.

One good way to achieve exposure to these sectors is via any number of sector ETFs currently on the market. These provide investors with diversified holdings across an industry, allowing for lower risk investing (also read Winning ETF Strategies for the Second Half of 2013).

While there are a number of choices in the more cyclical sectors, a great way to pick potential best performers is by using the Zacks ETF Rank. This system looks to take into account a variety of factors—such as industry outlook and expert surveys-- and then apply ETF-specific factors (like expense ratios and bid ask spreads) in order to find the best funds in each segment.

Using this system, we have found a handful of ETFs in cyclical sectors that have earned themselves a Zacks ETF Rank #1 (Strong Buy), and thus could be poised to outperform. And best of all, we have found three such funds that have seen their Ranks surge to this top echelon in the latest ratings update, suggesting now could be the time to buy the following three ETFs.

First Trust Industrials/Producer Durables AlphaDEX Fund (FXR - Free Report)

Good things could be ahead for the space based on the recent Philly Fed Business Outlook Survey, which thoroughly crushed expectations. The consensus called for a reading of 9.0 while the actual came in at 19.8, according to Bloomberg, pushing ahead of even the top of the consensus range.

This could suggest that the upcoming ISM number will be strong, and that manufacturing activity is back on track. Particularly this could be the case if exports and orders continue to post solid figures, giving plenty of reason to be optimistic about the sector.

One way to play this trend with a top ranked ETF is with FXR, a fund from First Trust. This ETF tracks the StrataQuant Industrials AlphaDEX Index, a benchmark that holds roughly 100 industrial stocks in its basket, using a modified equal weight system to achieve exposure (see Three Industrial ETFs for A Manufacturing Revival).

Basically, the index seeks to rank industrial stocks on a variety of growth and value factors, including price appreciation, book value to price, and ROA, among others. Then, the ETF eliminates the 25% bottom-rated stocks and then divides the rest into quintiles, equally weighting within each quintile, but giving more assets to the higher ranked groups.

This product has moved higher by 4.3% in the past month, compared to a 3.2% gain for SPY in the same time frame. Meanwhile, the ETF has achieved a Zacks ETF Rank of 1 (Strong Buy), meaning that this outperformance could certainly continue.

Select Sector SPDR Financials ETF (XLF - Free Report)

The broad financial sector has actually been a huge beneficiary of recent Federal Reserve policy discussions. That is because the steeper yield curve assists banking institutions in making more money, thanks to a bigger spread between short term rates for deposits, and longer-term rates for loans.

Additionally, the market has been a bit more volatile lately, although gains have certainly been had across the equity board. This situation is helping asset managers to bring in more capital, while exchange companies are seeing more activity too, suggesting good news all around for the space.

Easily the most popular and liquid way to play financials in basket form is with the widely traded XLF. This product sees close to 50 million shares change hands each day, while assets under management are pretty impressive at just over $16 billion.

The fund holds about 80 stocks in its basket, weighting by market capitalization for the exposure. Top companies include the usual suspects of Berkshire Hathaway, Wells Fargo, and JP Morgan, all of which account for more than 8% of the assets (also read Why IAI is a Great Financial ETF).

In terms of an industry breakdown, insurance takes the top spot at about 27% of assets, followed by broad financial services and then banks at around 20% each. Meanwhile, investors should note that mid caps only account for about 5% of the portfolio, leaving a heavy skew towards large cap securities.

This popular ETF has added about 5.4% in the past one month time frame, and it has earned itself a Zacks ETF Rank of 1 (Strong Buy).

iShares Dow Jones Transportation Average ETF (IYT - Free Report)

With increased industrial activity and a consumer willing to spend, the transportation industry has been a solid performer. Granted, investors did see some weakness from UPS lately, but such air-freight focused companies make up a pretty small portion of the index overall.

Instead, the important benchmark focuses in on railroads, trucking firms, and passenger transportation. All of these segments appear better positions thanks to decent commodity demand, a strong consumer which is helping to boost shipping demand of goods, and disposable income increases which are helping the passenger transportation segment to surge as well.

The most popular way to play this trend in ETF form is with iShares’ IYT, a price weighted ETF that tracks the transportation industry. The fund sees decent volume of about half million shares a day on assets that are about half a billion dollars, holding roughly 20 stocks in its portfolio (see the Guide to Transportation ETFs).

While ‘delivery services’ account for roughly 20% of assets, investors should note that railroads take up about 31% of the fund, while trucking and airlines also receive double digit allocations. Top holdings include Union Pacific, Kansas City Southern, and FedEx, with these three combining to account for about 30% of the total.

This ETF also has a large cap focus, although not as much as some of its peers, partially thanks to the price-weighting methodology. Instead, the fund puts about 50% in small and mid cap securities with mid caps making up 30% of the total ETF.

This fund has added about 4.7% in the past month, and currently has a Zacks ETF Rank of 1 (Strong Buy).

Bottom Line

The market is posting strong gains to open up the third quarter, with key indexes hitting all-time highs. While the rally has been pretty broad based, some sector leaders are definitely beginning to show themselves (see all of the Top Ranked ETFs here).

In particular, cyclically focused segments—such as industrials, transports and financials—have led the rally accounting for huge gains so far. And given that many of these trends are still in place in the market, these could be top sectors to push towards for the rest of the summer as well.

While there are a number of ways to do this, one overlooked way could be by taking a look at ETFs in these sectors that have seen their Ranks recently surge to the #1 level. These ETFs could be well-positioned to take advantage of the current market environment, and could continue to lead the way higher as stocks look to make new highs once more.

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