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3 Cyclical ETFs for an Improving Economy

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Markets have remained range bound of late as participants continue to analyze every bit of economic or Fed related news for clues regarding ‘tapering’ of the QE program. Federal Reserve’s FOMC minutes released last week failed to shed much light, and recent remarks by some of the Fed officials have only added to the uncertainty. In anticipation of the inevitable winding down of the bond purchase program, interest rates have been creeping up.

On the other hand, the US economy continues on its slow and steady growth path. During the second quarter, the economy grew at 2.5% annual rate, an upward revision from 1.7% reported earlier and better than the consensus estimate of 2.2%.  (Read: 3 Excellent ETFs for Growing Dividends)

Higher exports and business investment suggested that the momentum will continue into the second half of the year. The drop in weekly Jobless Claims also pointed towards improvement in the labor market. Even though quarterly results from some companies have caused some concerns, the overall economic picture continues to improve slowly. (Read: High Dividend ETFs to buy even if Fed Tapers)

As a result of favorable economic environment, cyclical sectors like Technology, Industrials and Consumer Discretionary can be expected to deliver better returns in the months to come. Improved outlook for these sectors is reflected in expected earnings growth rates in 2014 for these sectors (source: Zacks Earnings Trends):

  Earnings Growth
  2013 E 2014 E
Consumer Discretionary 12.8% 16.5%
Industrial Products 1.3% 12.0%
Technology 0.6% 12.2%

Many of the cyclical stocks had lagged behind the boring, defensive stocks that found investors’ favor earlier this year.  As a result some of them look quite attractive on valuation basis currently. Further, these sectors can be relied upon to deliver outsized returns when the economy improves. Below we have analyzed three ‘Buy’ rated ETFs from these sectors. (Read: Senior Loan ETFs-the best bet for rising rates?)

iShares U.S. Industrials ETF (IYJ)
Manufacturing activity has been showing strong signs of revival, not only in the US, but also in China and Europe. Healing labor markets and rising consumer confidence have boosted the demand for manufactured goods.  Improvement in housing markets also resulted in increased demand for appliances and furniture.

IYJ which tracks the Dow Jones U.S. Industrials Index, made its debut in June 2000. It has so far amassed $1.2 billion in assets, which are invested in 223 securities. The fund charges an annual fee of 46 basis points for its services, while the dividend yield is decent at 1.41%.
GE is the top holding in the fund with 10.8% of assets, followed by United Technologies and Union Pacific. From the sector perspective, General Industrials (21.3%) occupy the largest weight, followed by Support Services (18.1%) and Aerospace & Defense (16.7%).
IYJ is currently a Zacks Rank #2 (Buy) ETF.

Guggenheim S&P Equal Weight Technology ETF (RYT - Free Report)

Technology sector did not get investor attention this year as some of the mega players in the sector reported uninspiring results. As a result, the sector looks quite attractive from valuation perspective. With an improving economy, tech stocks are expected reported higher earnings in the coming quarters. Another reason to be bullish on the sector is increasing dividends and buybacks by tech companies.
RYT tracks the S&P 500 Equal Weight Index Information Technology, holding 70 securities in the basket.  Launched in November 2006, the product has so far attracted $225.6 million in assets, which are invested in 70 securities.

Due to its equal weight methodology, the product greatly reduces company specific risks. Further as many of the bigger tech names have been struggling this year, this product has been outperforming its market cap weighted peers significantly.

Semiconductors (23.0%), IT Services (20.3%) and Software (17.9%) occupy the top spots in terms of sector allocation.  The product charges an expense ratio of 50 basis points.

RYT is currently a Zacks Rank #2 (Buy) ETF.

First Trust Consumer Discretionary AlphaDEX Fund (FXD - Free Report)

Consumer discretionary sector has been outperforming the broader market for some time now and the sector does not look cheap from valuation perspective. However, this sector’s performance is closely related to the state of the economy and it has historically rewarded investors with outsized returns when economic picture improves.

FXD tracks the StrataQuant Consumer Discretionary Index which employs the AlphaDEX stock selection methodology. The fund is one of the popular Consumer Discretionary equity ETFs with more than $736.2 million in AUM, which are invested in 131 holdings. With just 14% of its total assets in the top 10 holdings, the product has little concentration risk.

The product has double-digit allocations to Specialty Retail (21.3%), and Media (16.7%), whereas Tesla Motors, Nu Skin Enterprises and Netflix are its top three holdings.
The product charges a slightly higher fee of 70 basis points per year for its ‘enhanced’ stock selection methodology.  
FXD is a Zacks Rank#1 (Strong Buy) ETF.

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