Mutual Fund Commentary
INDUSTRIALS POISED TO OUTPERFORM
The industrials sector, which has underperformed the S&P 500 thus far in 2014, is one which S&P Capital IQ recommends investors overweight in their portfolios, especially as the global economy continues to mend.
S&P Capital IQ retains a positive 12-month fundamental outlook on industrials as it sees expected sales benefits from higher emerging- and frontier-market exposure, stabilization in Chinese gross domestic product growth in the 7.5% area, Europe's return to growth, and an improving U.S. recovery coupled with easing fiscal drag. In addition, S&P Capital IQ notes operating leverage in the sector is rising with revenues thanks to aggressive cost cutting and manufacturing automation initiatives put in place by most companies during the extreme business downturn of 2008 and 2009.
Overall, S&P Capital IQ expect the sector to outperform the broader market for all of 2014.
This view is espoused by S&P Capital IQ despite the industrials sector's underperformance against the broader benchmarks for the year to date through February 24. Thus far, the multi-cap S&P Composite 1500 Industrials Index is down 1.2% versus a fractional increase in the broader S&P Composite 1500 Index. Similarly among large caps only, the S&P 500 Industrials Index has retreated 1.5% versus a flat showing for the S&P 500.
"We think the U.S. economy hit a soft patch to start the year, with a deceleration in several indicators we track, such as the Architectural Billings Index and industrial production and capacity utilization," notes Jim Corridore, an S&P Capital IQ equity analyst.
"However, we expect improvement in these metrics and others as we move through the year, and we think that stocks within the industrials sector will be a beneficiary of this increase in activity that we foresee," he adds.
This year-to-date lackluster track record follows a strong 2013, a year in which the sector outperformed the broader market. The composite sector index rose 41.2% versus a 30.1% gain for the broader 1500 index. Among large caps in the sector, stocks rose 37.6% versus 29.6% for the 500.
For investors seeking diversified exposure to the sector, S&P Capital IQ recommends investigating these four exchange-traded funds (ETFs), which garner S&P Capital IQ's top "overweight" ranking based on our proprietary ETF ranking methodology that incorporates not only past performance, but also risks, costs, and an assessment of the likely future performance of underlying holdings.
The Fidelity MSCI Industrials Index ETF (FIDU 27 Overweight) ranks positively in both risk considerations and cost factors, but receives a neutral assessment of its performance analytics. In terms of asset allocation, the ETF is heavily weighted towards the biggest domestic companies of the sector. Of its $54 million in assets under management, the ETF is 95% U.S.-listed companies, of which 56% are mega caps and 23% are large caps.
The larger Industrial Select Sector SPDR Fund (XLI 51 Overweight) ETF is similarly weighted towards big domestic industrials. Of its $9.2 billion under management, 70% of assets are invested in U.S. mega caps and 24% in large caps. The ETF's overweight ranking is based on S&P Capital IQ's positive assessment of its costs and risks. But the ETF receives a neutral assessment of its performance.
Performance is also an issue with the iShares US Industrials ETF (IYJ 100 Overweight), which receives a neutral assessment by S&P Capital IQ. The ETF's risks and costs, however, are viewed more positively, hence its overall overweight ranking. Behemoth domestic companies are also prominent holdings for this ETF as U.S. mega caps constitute 53% of assets and large caps, 27%.
The Vanguard Industrials Index ETF (VIS 99 Overweight) is similarly weighted with 54% of constituents in the ETF considered U.S. mega caps, and 24% as large caps. But this ETF receives neutral inputs for its performance and risks with a positive assessment of its costs, which contributes to its overall overweight ranking.
The iShares US Aerospace & Defense ETF (ITA 109 Overweight) receives a positive assessment of its performance, but its risks and costs are neutral inputs to the ETF's overweight ranking. Furthermore, as its name implies, 94% of its holdings operate in the domestic aerospace & defense industry, which is the largest in terms of the sector's market value. As a result of this narrow focus, mega caps are less than half of holdings at 47% and large caps, 16%.