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Zacks #2 Ranked Industrial ETF in Focus

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With the implementation of the third round of quantitative easing (QE3) and the extension of operation twist aimed at keeping long term borrowing costs low, the markets seem to be flooded with liquidity. Many are hoping that these low borrowing costs will ensure high levels of consumption, and thus jumpstart the economy heading into 2013.

At least on some level, this appears to be working as many are starting to spend again. After all, there is rising consumer confidence, an increase in employment levels and growing personal consumption expenditure (PCE) that the U.S. economy has seen of late. With this backdrop one could argue that the much-condemned efforts of the central bank have not gone in vain (read Spending is Surging: Stock Up on These ETFs).

Everything seemed to be going as planned until ‘Superstorm’ Sandy showed up and created havoc mostly along the eastern region of the US. While it had its effects in almost all sectors of the economy, primarily the energy and industrial sector have been the worst affected (see Time to Buy the Oil Equipment ETFs?).

Nevertheless, the industrial sector seemed to be enjoying a decent run this fiscal both in terms of earnings growth and stock market performance. Industrials are one of the leading contributors in terms of earnings growth as well as the bull run in the market (read State Street Debuts Unique Momentum and Value ETFs).

However, the industry had faced a severe hiccup on account of the hurricane as industrial production slumped by 0.4% in October after an increase of 20 basis points in the preceding month (according to the data provided by the Federal Reserve).

This has gone a long way in hurting investor confidence as the sector companies witnessed sell offs after the hurricane episode. Nevertheless, with the holiday season approaching and the housing sector recovery constituting definite key positives going forward, as the top lines are expected to increase on account of increased demand for intermediate products.

Investors can easily target the producers of these intermediate products by playing the industrial sector. This segment could be a less bid up way to play the market, while still targeting positive trends (see ETFs That We Are Thankful For).

Given this, a look at a top ranked industrial ETF could be the way to target the best of the segment with lower levels of risk.

About the Zacks ETF Rank

The Zacks ETF Rank provides a recommendation for the ETF in the context of our outlook of the underlying industry, sector, style box, or asset class. Our proprietary methodology also takes into account the risk preferences of investors as well.

The aim of our models is to select the best ETFs within each risk category. We assign each ETF one of five ranks within each risk bucket. Thus, Zacks Rank reflects the expected return of an ETF relative to other ETFs with similar level of risk.

Using this strategy, we have found an ETF Ranked 2 or ‘Buy’ in the Industrial Sector which we have highlighted in greater detail below:

Industrial Select Sector SPDR (XLI)

Launched in December of 1998, XLI tracks the performance of companies listed in the S&P 500 which belong to the industrial sector. The ETF has had a decent run so far this year returning around 9% as of 20th November 2012, compared to the S&P 500 returning 10.35% for the same time period (see more in the Zacks ETF Center).

The ETF had been hit hard by the fall in industrial production which has affected the overall sector. This coupled with the sharp post-election sell-off from the equity markets have led to lose a bit in AUM for much of November.

XLI has an asset base of around $3.24 billion and does an average volume of around 14 million shares daily. It charges investors 18 basis points in fees and expenses and pays out a yield of 2.19%. It holds around 64 securities in its portfolio with around 50% allocation in the top 10 holdings (read Forget Interest Rate Risk with These Bond ETFs).

In terms of individual holdings, General Electric Co. accounts for a lion’s share of its portfolio with around 12.5% allocation. United Technologies Corp (5.19%), Union Pacific Corp., (4.80%) and 3M Co. (4.54%) are some of its other top holdings.

From a risk analysis point of view, XLI has a relatively lower annualized standard deviation of 22.50%. This reflects our ‘Low’ risk outlook for the ETF along with a Zacks Rank of 2 or ‘Buy’, suggesting this could be a less volatile way to target the market as we head into 2013.

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