The U.S. stock market has shown strong resilience over the past few months outplaying lofty valuation concerns and global turmoil following geopolitical tensions in Russia, Ukraine and Iraq, sluggish Euro zone recovery and stability in China. This is especially thanks to an accelerated job market, regained housing market momentum and stepped-up economic activities after the first-quarter slowdown.
Further, renewed tensions between Ukraine and Russia due to fresh sanctions by the West, and the crackdown of a Malaysian Airlines jetliner near the Russian/Ukrainian border appear to only be temporary setbacks. The stock market has already endured such threats a number of times this year (read: Russian Sanctions and Malaysian Plane Crash Put These ETFs in Focus).
Given bullish fundamentals and growing optimism, a New York-based research firm, Goldman Sachs (GS), lifted its expectation for equity returns. The S&P 500 index is expected to climb to 2,050 by the end of 2014 from the previous projection of 1,900. This represents a modest 3.6% gain from the close of the last trading session. Most of the gains will likely come from strong earnings, which is expected to grow 8% annually.
According to David Kostin at GS, the equity rally will be at the shallow pace. Though domestic economic growth is improving and earnings will continue to rise, the market expectation for the Fed hike within 12 months could limit the P/E multiple expansion. The S&P 500 index currently trades at 15.5 times the forward 12-month earnings, much higher than the 5-year and 10-year historical averages of 13.5 and 14.1 but below the loft days of the tech bubble in the late 90s.
Further, the U.S. equity market also appears attractively valued when compared to bond markets. This is especially true as the fixed income strategists at GS lowered the 10-year Treasury yield forecast by 25 bps to 3% on improving economy that could lead to interest rate hike in the third quarter of next year.
In fact, Kostin expects “lower valuation stocks and those with weak balance sheets, low returns on capital and low margins will lead the market’s gains before the Fed’s interest rate tightening’’. Investors seeking to ride on Goldman’s views could choose from a variety of products available in the ETF form.
While several ETF options could make a great play if Goldman Sachs’ prediction comes true, we have highlighted three funds that also have a favorable Zacks ETF Rank of 1, 2 or 3.
Vanguard Value ETF ((VTV - ETF report) )
For a pure play on lower valuation, investors could focus on value ETFs like VTV. This fund seeks to track the CRSP US Large Cap Value Index, which measures the performance of a number of the largest U.S. value stocks. With AUM of $14.7 billion and an expense ratio of 9 bps, VTV is one of the largest and cheapest funds within the space (read: 3 Excellent Value ETFs Poised to Outperform).
The fund holds 311 stocks, which are pretty well spread across each component as none of these holds more than 4.2% share. Exxon Mobil (XOM), Microsoft (MSFT - Analyst Report) and Johnson & Johnson (JNJ) occupy the top three positions in the basket. From a sector look, financials take the top spot with one-fifth share while health care, industrials and oil & gas round off to the next three spots with double-digit allocation.
The ETF sees solid trading volume of more than 726,000 shares, suggesting a slight extra cost in the form of tight bid/ask spread. The product added 8.6% in the year-to-date time period and has a Zacks Rank of 2 or ‘Buy’ rating with Medium risk outlook.
iShares North American Tech-Multimedia Networking ETF ((IGN - ETF report) )
Since the information technology sector holds a large basket of weak balance sheet stocks and accounts for more than half of the market’s outperformance so far this year, investors could find IGN an intriguing pick. This ETF provides a concentrated exposure to the domestic multimedia networking securities by tracking the S&P North American Technology-Multimedia Networking Index.
Holding 25 securities in its basket, the product is heavily concentrated on some of the lowest valuation and weak balance sheet stocks. Some of these are Cisco (CSCO - Analyst Report) , Qualcomm (QCOM), F5 Networks (FFIV), Motorola (MSI - Analyst Report) and Juniper (JNPR - Analyst Report) which collectively account for nearly 43% of total assets (see: all the technology ETFs here).
The fund has accumulated $323.5 million while sees a moderate volume of nearly 68,000 shares a day. Expense ratio comes in at 0.47%. The fund is up 7.7% so far this year and has a Zacks ETF Rank of 2 with High risk outlook.
iShares U.S. Healthcare Providers ETF ((IHF - ETF report) )
Investors playing on Goldman’s prediction could also focus purely on the healthcare sector with IHF, as the fund holds a number of stocks with a weak balance sheet that have outperformed its rivals. This ETF provides exposure to U.S. companies that provide health insurance, diagnostics and specialized treatment by tracking the Dow Jones U.S. Select Healthcare Providers Index (read: Healthcare ETFs in Focus on JNJ Earnings).
In total, the fund holds 49 securities in its basket with the largest allocation going to United Health (UNH) and WellPoint at 13.43% and 6.94%, respectively. Other firms hold less than 2.8% of IHF. The fund has been able to manage $511.1 million in its asset base while volume is light. It charges 43 bps in annual fees and expenses.
The ETF returned about 13% in the year-to-date time frame and has a Zacks ETF Rank of 3 or ‘Hold’ rating with Medium risk outlook.
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