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Tackle Trump & the Fed with These Cyclical Sector ETFs

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The U.S. economy gained its lost ground to start the second half of the year, though not fully but surely more than what we saw early this year. In Q3, the economy logged a 2.9% annualized growth rate, after a 1.4% rise the previous quarter and beating the forecast of 2.6% growth.

Several economic readings came in favorable lately. To add to this, “the U.S. is expected to lead global growth higher over the next two years despite the growing threat posed by protectionist policies” as per Moody’s Investors Service.

With such optimism playing at the background, U.S. president-elect Trump came up with his ‘America First’ idea and pledged to boost fiscal spending as well as enact a lenient regulatory environment and lower taxes. All these boosted the inflationary outlook, the U.S. dollar to a decade high and pushed up the benchmark U.S. Treasury bond yield.

To add to this, the Fed chair Yellen lately cemented the speculation about a sooner-than-expected rate hike. With 100% chances of a December hike, the yield on benchmark U.S. Treasury note jumped to 2.36% on November 23 from 1.83% at the start of the month.

Wealth Effect to Be Created?

The S&P 500 has rallied over 3% since election (as of November 23, 2016) and has hit a record high. A flurry of strong economic data points and hopes of more fiscal stimulus infused new-found optimism to this index.

Even the Dow Jones industrial average appears to be on cloud nine, having crossed 19,000 for the first time in its 120-year history on November 22 to celebrate the Trump victory. If this ascent is maintained, a wealth effect can be realized.

As per Investopedia,the wealth effect helps to power economies during bull markets. Big gains in people's portfolios can make them feel more secure about their wealth and their spending.”

And in a growing economy, most sectors surge from a wealth effect, with a few of the more cyclical corners making the most of this run-up. These industries often sag in a slumping economy, but are the biggest winners when rays of hope are seen.

Cyclicality of Sectors

While some view policy tightening as a negative for stocks, investors should remember that the latest Fed move bears testimony to an improving economy. Historically, cyclical sectors outperform the defensive ones when rates normalize.

If the Fed hikes rates in the coming month (which has a high chance), it is likely to be in the range of 25–50 bps. This bit of policy tightening should be plausible for cyclical stocks to advance. Moreover, defensive sectors had a stellar show earlier this year, while cyclical stocks lagged. This made the valuation of cyclical sectors pretty fair.

As a result, a few cyclical sectors and related ETFs are expected to perform well ahead. For these investors, we highlight five ETF picks below that have heavy exposure to the cyclical industries.

Compare the metrics mentioned below for the set of ETFs with the Zacks Rank #3 (Hold) SPDR S&P 500 ETF SPY which has 8.3% YTD gains (as of November 23, 2016) and a P/E of 17.73x

PowerShares S&P Small Cap Consumer Discretionary ETF PSCD

A small-cap consumer discretionary ETF can be considered a barometer of rising income levels of consumers. These pint-sized stocks do not have much exposure in foreign lands and are thus unaffected by the dollar strength (read: Confident About Trump Rally? Play These Small-Cap Blend ETFs).

P/E: 18.31x

Zacks Rank: #2 (Buy)

PowerShares KBW Regional Banking Portfolio (KBWR)

A rising rate backdrop is a tailwind for banking stocks as these improve banks' net interest margins (read: Play Banking Bonanza with These ETFs in Trump World).

P/E: 15.53x

Zacks Rank: #2

PowerShares S&P SmallCap Industrials ETF PSCI

Industrial stocks should perform well if Trump’s promises to bring manufacturing jobs back to America are kept (read: Manufacturing Reshoring Ahead? ETFs to Profit).

P/E: 18.50x

Zacks Rank: #2

SPDR S&P Semiconductor ETF XSD

The technology sector bounced back lately after skidding on Trump win as uncertainties regarding trade, immigration and outsourcing loomed large. Out of the broader tech sector, semiconductors appear especially well placed thanks to the rise of a new growth area – Internet of Things (IoT) (read: Invest in the Internet of Things with This ETF).

P/E: 19.44x

Zacks Rank: #2

First Trust Materials AlphaDEX Fund (FXZ - Free Report)

Trump’s planto boost infrastructure spending can also do wonders for this segment if the policies see the light of the day. The fund gives exposure to stocks from the Russell 1000 Index, screened on the basis of several growth and value criteria.

P/E: 17.60x

Zacks Rank: #1 (Strong Buy)

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