ETF Trends
ETF Trends

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).

Additionally, as signs of an economic slowdown pop up, investors turn to defensive sectors that are less economically sensitive, such as health care. Investors have taken on greater exposure to the health care sector through ETF options like the Health Care Select Sector SPDR (NYSEArca: XLV), iShares U.S. Healthcare ETF (NYSEArca: IYH), Vanguard Health Care ETF (NYSEArca: VHT) and Fidelity MSCI Health Care Index ETF (NYSEArca: FHLC).

On the other hand, Fidelity warned that information technology and consumer discretionary sectors have most often fallen behind during the late-cycle phase as inflationary pressures weigh on profit margins and investors shift away from more sensitive areas.

Additionally, the third quarter profit tallies also reveal a divergence between domestically oriented operations and U.S. companies with a greater foreign footprint where the stronger U.S. dollar has negative affected profits. Domestic profits rose $7.3 billion in the third quarter, or 0.4%, and only down 2.8% year-over-year. In contrast, foreign profits declined $30 billion, a 7.4% fall from the second quarter and 12.2% lower year-over-year.

Investors can also track more domestically focused U.S. companies through small-cap ETF options like the iShares Core S&P Small-Cap ETF (NYSEArca: IJR), which tracks the S&P SmallCap 600; Vanguard Small Cap ETF (NYSEArca: VB), which follows the CRSP US Small Cap Index; the iShares Russell 2000 ETF (NYSEArca: IWM), which tracks the Russell 2000 Index; and Schwab U.S. Small-Cap ETF (NYSEArca: SCHA), which tracks the Dow Jones U.S. Small-Cap Total Stock Market Index.

For more information the U.S. markets, visit our current affairs category.

Max Chen contributed to this article.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.