Where Can The Next Big ETF Sector Be Found?

As the economic recovery begins to take shape, investors are throwing money back into the markets and exchange traded funds (ETFs). But investors aren’t just randomly selecting sectors, hoping to strike it rich at the next big thing.

Investors still have to decide on which industries are best positioned to perform well in the recovery, remarks Matt Krantz for USA Today. Possibly the worst thing any investor could do is jump in after sectors that have already gained, continually chasing performance.

After betting on financials and tech companies, investors are now looking for actual economic growth in the second half of the year, especially in consumer discretionary companies that make big-ticket items such as automobiles and appliances. Krantz notes, however, that investors are applying prudent techniques when picking out future winning sectors:

History. Certain sectors and certain companies do better at certain points of an economic cycle. If the past repeats itself, solid performance could come out of consumer discretionary stocks, along with materials and industrial companies. These “cyclical” sectors could gain as demand for goods picks up. Later, energy stocks could gain as companies expand to cover all the demand.

• Consumer Direct Select Sector SPDR (XLY): up 30% year-to date
• iShares Dow Jones U.S. Basic Materials (IYM): up 55% year-to-date
• SPDR Select Sector Fund- Basic Industries (XLB): up 43% year-to-date
• Energy Select Sector Energy Fund (XLE): up 17.7% year-to-date

Cycles. Growth in revenue is still down and may continue to be so in the third quarter, but some businesses could show early growth. The businesses that will perform will be the ones to stop cost cutting and start expanding. This is one of the reasons why financials may continue to benefit as demand for loans increases.

• SPDR Financial Select Sector (XLF): up 23.3% year-to-date

Diamonds in the rough. Some small banks and brokers may stand out by enticing customers who have become estranged from large financial firms. Modernization of bridges and roads will lead to a boom in the infrastructure industry. Government investment into green tech will also likely help the alternative energy industry. As more companies use the internet to conduct business, business that build internet networking systems may also become in demand.

• iShares S&P Global Infrastructure (IGF): up 13.8% year-to-date
• PowerShares Wilderhill Clean Energy Portfolio Fund (PBW): up 28.9% year-to-date
• iShares Networking Fund (IGN): up 61.7% year-to-date

Not so good. Sectors dependent on consumers may not see previous cash flows for awhile yet. Businesses such as retailers, restaurants and casinos may also continue to struggle.

Watch the trends. There’s no such thing as a “sure thing” in the markets, otherwise no one would ever lose anything. We can all guess which sectors will perform and which won’t, but reality could bear out differently. Watch the trend lines to spot the true opportunities, and have a stop loss in place, as well.

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