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3 Top Ranked ETFs from Red Hot Sectors

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Politicians in Washington finally managed to arrive at a last-minute deal to avoid the disaster, even though the solution is only a temporary one. The stock market rejoiced the deal, more so because the fiscal uncertainty will most likely prevent the Fed from scaling back the monetary stimulus anytime soon.

Leaving the budget battles and debt-ceiling debate behind, the market is now focused on earnings. Third quarter earnings have been a mixed bag so far, but at the same time, investors are clearly rewarding stocks and sectors that have been beating or are expected to beat earnings estimates. One easy way to identify sectors with improving earnings prospects is to look at Zacks Industry ranks, which are based on earnings estimates revisions.

And a good way to achieve exposure to those sectors is to invest in ETFs that have earned top Zacks ranks, based on their potential to outperform their peers. (Read: High-Quality ETFs for Long-Term Performance)

SPDR KBW Regional Banking ETF (KRE - Free Report)

Finance has been the earnings growth leader this year and the sector has not disappointed so far in the third quarter. Per Zacks Earnings Trends, Finance sector earnings for the 60.1% of the sector’s total market capitalization that have reported already, are up +13.0%.  And, while the growth momentum is slowing, they are expected to deliver a double-digit earnings growth in the fourth quarter as well. Finance is currently #9 (out of 62) on the Zacks M (medium level) industry list.

Within the broader financial sector, I prefer regional banks. Most of the larger banks are hit by stringent regulatory requirements, falling trading revenues and costly settlements.  Regional banks have been leading the sector most of this year as they were the main beneficiaries of steepening yield curve and rising rates.  Then, they were big sufferers of the no-taper shocker.

But interest rates are expected to rise from the current levels when the taper-talk returns, benefiting regional banks.

Further, many of the regional banks are seeing a pick-up in commercial lending, which will partly offset the effect of decline in mortgage business. (Read: 3 Excellent ETFs for Growing Dividends)

KRE is the most popular regional banking ETF, with more than $2.3 billion in assets under management. The ETF holds 81 stocks in its portfolio, mostly small and mid caps. The fund uses an equal weight methodology, so company-specific risk is largely eliminated as no single company makes up more than 1.7% of the asset base.

KRE is a Zacks rank #1 (Strong Buy) ETF. (see all the Top Ranked ETFs here).

PowerShares Dynamic Leisure & Entertainment ETF (PEJ - Free Report)

Per FactSet, Consumer Discretionary sector has the highest earnings growth rate of all ten S&P sectors at 6.6% for the third quarter. Further it is one of the few sectors that are expected to see a double digit earnings growth in the fourth quarter as well.  (Read: 3 Safe ETFs to buy in the next shutdown)

Consumer discretionary and retail stocks have been doing pretty well this year as the labor market showed clear signs of healing. Further, rising housing market and surging stock market added to the “wealth effect”, resulting in rising consumer confidence. 

While the consumer confidence had slipped recently thanks to uncertainty created by the drama in Washington, the resolution thereof even though temporary would have lifted consumers’ spirits.

Leisure and Entertainment sub-sector within this space is also likely to benefit from the upcoming holiday season. "Leisure Service" is # 1 on the Zacks ‘M’ Industry Rank list as of now and “Other Consumer Discretionary” is #3.

Launched in June 2005, PEJ the tracks Dynamic Leisure and Entertainment Intellidex Index. 
The index is comprised of 30 US leisure and entertainment companies selected on the basis of a variety of investment merit criteria, including: price momentum, earnings momentum, quality, management action, and value.

Top holdings include Chipotle, Time Warner, Liberty Media, Priceline and Starbucks. Restaurants (43%), Broadcasting (15%), and Movies & Entertainment (13%) are among the top industries.

The fund charges slightly higher fees of 63 basis points per year but it has been outperforming its peers.

PEJ is a Zacks rank #1 (Strong Buy) ETF.

SPDR S&P Aerospace & Defense ETF (XAR - Free Report)

Despite budget related worries, this small sector has been doing very well this year, mainly due to strong momentum in the commercial aviation market. "Aerospace & Defense" is currently #10 (out of 62) on the Zacks M industry list.

Third quarter earnings have been good so far, with 83.3% earnings beat ratio and 66.7% revenue beat ratio.

Launched in September 2011, this product tracks S&P Aerospace and Defense Select Industry index, which is a modified equal weight index.

This product has attracted AUM of $22.2 M so far. It holds 36 securities with weighted average market cap of $21 billion. It charges 35 basis points in expenses and has a decent dividend yield of 1.8% currently.

Boeing, Alliant Techsystems, Hexcel Corporation and Northrop Grumman are the top holdings but being modified equal weighted, the fund is pretty well diversified with the top holding accounting for just 4.7% of total assets.

XAR is a Zacks Rank#1 (Strong Buy) ETF.

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