Sector ETFs for the Late Business Cycle

U.S. companies recently revealed their largest annual profit decline since the recession, suggesting that the economy and stock exchange traded funds are moving toward the late-cycle phase.

Corporate America’s profits dropped to $2.1 trillion in the third quarter, or down 1.1% from the second quarter, and fell 4.7% year-over-year, the largest annual decline since the second quarter of 2009, the Wall Street Journal reports.

Looking ahead, economists warn that the weak profits could depress business investment and drag on stock prices that some believe are overpriced.

“Profits are slowing, there’s no way around that,” Deutsche Bank chief U.S. economist Joseph LaVorgna told the WSJ. “These are things that suggest we’re past the midpoint of the business cycle, unfortunately, but it doesn’t mean we can’t run this [expansion]a bit longer.”

Consequently, investors should start thinking about positioning in the late-cycle phase. According to Fidelity, the late-cycle phases had an average duration of about a year and a half, with overall stock market performance of a little over 5% on an annualized basis.

As the economic recover matures, energy and materials sectors have done well as inflationary pressures build and late-cycle economic expansion helps support demand. ETF investors in the oil industry can track broad sector plays like the Energy Select Sector SPDR (NYSEArca: XLE), Vanguard Energy ETF (NYSEArca: VDE), iShares U.S. Energy ETF (NYSEArca: IYE) and Fidelity MSCI Energy Index ETF (NYSEArca: FENY). For materials exposure, investors can look to the Materials Select Sector SPDR (NYSEArca: XLB), Vanguard Materials ETF (NYSEArca: VAW), iShares U.S. Basic Materials ETF (NYSEArca: IYM) and Fidelity MSCI Materials Index ETF (NYSEArca: FMAT).