In what may be a sign that a legitimate cyclical rotation is underway, industrial sector ETFs soundly outpaced the broad market in the third quarter. The S&P 500 gained 4.6% during the third quarter, but that is paltry compared to returns offered by industrials, the benchmark index’s fifth-largest sector weight.
During the third quarter, the Industrial Select Sector SPDR (NYSEArca: XLI) rose 8.2% while the iShares U.S. Aerospace & Defense ETF (NYSEArca: ITA) continued its impressive year-to-date run, gaining 11.8%. ITA, home to Dow components Boeing (NYSE: BA) and United Technologies (NYSE: UTX) among others, has defied expectations this year. The ETF has surged 36.1% despite predictions that aerospace and defense names would be vulnerable to budget cuts on Capitol Hill. [Aerospace ETFs Face Sequestration Debate]
XLI, ITA and rival funds like the Vanguard Industrials ETF (NYSEArca: VIS) could may have more upside in store.
“According to Michael Jaffe, Group Head of Industrials equity research for S&P Capital IQ, the primary reasons for his team favoring a number of Industrial stocks at this time are that European economies finally seem to be stabilizing after a lengthy downturn, and that business trends in China seem to be bouncing back following a period of sluggishness. In addition, Jaffe sees recovery of housing markets in the U.S.boosting several areas of the Industrial sector, as materials and equipment are needed for both the building of new homes and the renovation of existing homes,” according to a new research note by S&P Capital IQ.
S&P Capital IQ has overweight ratings on XLI, ITA and VIS as well as the iShares U.S. Industrials ETF (NYSEArca: IYJ).
Bolstering the case for industrial ETFs are favorable seasonal trends. Although October is not a great month for stocks and a downright bad month for gold and small-caps, the tenth month of the year has been historically a good time to establish positions in cyclical sectors. [Industrial ETFs for a Year-End Rally]
Additionally, the industrial sector ranks as second-best behind consumer discretionary in terms of returns when interest rates rise. That is something to consider if tapering talk comes back.
With an expense ratio of 0.14% per year, the $1.3 billion VIS is the cheapest of the ETFs highlighted by S&P Capital IQ. XLI is the largest with $6.8 billion in assets. In addition to Boeing and United Technologies, XLI’s top-10 holdings include three other Dow stocks – General Electric (NYSE: GE), 3M (NYSE: MMM) and Caterpillar (NYSE: CAT).
GE, United Technologies, Boeing, 3M and Caterpillar, in that order, combined for 26.4 of Vanguard Industrials ETF’s weight at the end of August, according to issuer data.
Vanguard Industrials ETF
ETF Trends Editorial Team contributed