As stated in my latest book, Investing With Intelligent ETFs
(FT Press/Minyanville, 2012), among the most important determinants of portfolio profitably is picking the right sectors. In good markets and in bad markets there is a wide difference between the performances of different sectors. Often the yearly difference between the top-performing sector and the bottom-performing sector is over 40%. An investor or trader can concentrate on finding which sector will outperform the S&P 500 Index
(INDEXSP:.INX) and buy an ETF in that sector. There are not many ways to beat the S&P 500, since that index is constructed to represent the overall market. And the downside to attempting to outperform is that the asset class chosen might underperform, as was the case with emerging markets over the last several years. But outperformance is what investors are seeking, and a way to do this is to be in the right asset classes.
A Sector to Consider for Outperformance
With the Fed signaling that it might tighten credit, one consequence could be that inflation comes back. One sector that can be bought as a hedge against inflation is the energy sector. The Energy Select Sector SPDR
(NYSEARCA:XLE), which uses the same stocks as the S&P 500 Index energy sector, is one of the ETFs that offers energy-sector exposure. XLE’s P/E ratio is about 14 times, which is reasonable. And as the demand for energy increases, the price of oil could increase, and there could be a multiple expansion. XLE is composed of mostly large-cap companies, which gives exposure to large companies that are involved in worldwide production, marketing, and distribution.
Another option, and one that could outperform, is the PowerShares Dynamic Oil and Gas Services ETF
(NYSEARCA:PXJ). This ETF is composed of 30 US companies involved in the production, processing, and distribution of oil and gas. PXJ uses its PowerShares Intellidex Index, and includes companies that are engaged in the drilling of oil and gas wells; that manufacture or assist in manufacturing oil- and gas-field machinery and equipment; that provide services to the oil and gas industry, including such activities as well analysis, platform and pipeline engineering and construction; and that are engaged in the logistics and transportation services, as well as oil- and gas-well emergency management and geophysical data acquisition and processing.These are generally smaller companies and, therefore, they are engaged more in domestic oil and gas industry activities, giving exposure to the US domestic oil and gas market. The breakdown of market-cap sizes in PXJ is the following: large cap, 25%; mid cap, 40%; small cap, 35%.
Emerging Markets Should Do Better This Year
Many investors have run out of patience with emerging markets. They have been told to invest in this market for the long term, but emerging-markets ETFs have had disappointing performances relative to US stocks. More patience is required as developed countries’ ETFs keep improving relative to emerging markets' ETFs. There are signs that in 2014, investors will be rewarded for holding emerging markets. These markets are cheap on a valuation basis, and the longer their economies stay stable -- instead of collapsing, as some pundits are predicting -- the better the chances this sector will snap back on the upside.
China’s economic problems, including its slowing growth rate, have been well-documented. But China, along with other emerging-market countries, has a higher growth rate than the US and many developed countries. Companies in China and in many emerging countries have lower multiples than companies in the US and in many developed countries. At this point, emerging markets could be a bargain.
For instance, Taiwan’s economy is expected to grow 3.6% in 2014, about in line with global growth, according to Australia and New Zealand Banking Group
(OTCMKTS:ANZBY). ANZBY noted that the US economy is a major end-user market of goods manufactured in Asia. The activity will expand, the bank said, and pointed to the strength of its purchasing managers' index. The index forecasts 3.1% economic growth in the US for 2014, which would be up substantially from the US growth of 1.6% in 2013. China will continue to be another growth driver, as it has become Taiwan's largest export market, accounting for about 40% of the total, the bank said.The bank projects that China's economy will rise by 7.2% in 2014. This pace, although below the average rate of previous years, will provide more opportunities for Taiwan's manufacturers.
One ETF that should share in a rebound in Taiwan and emerging markets is the WisdomTree Emerging Markets Small-Cap ETF
(NYSEARCA:DGS). The largest country allocation in DGS is Taiwan, with a 27% allocation. Other large allocations are South Korea, 10%; Malaysia, 9%; and South Africa, 9%. If the emerging markets in Asia do rebound, DGS should perform.
A Way to Buy China and the Developed Countries
An ETF to buy for exposure in the developed countries as well as the emerging countries is the RevenueShares ADR ETF
(NYSEARCA:RTR). RevenueShares weights its ETFs by sales, giving the heaviest weight to those companies with the highest sales per share. RTR uses the same securities as the S&P ADR Index
(INDEXSP:SPADR). At a price/sales of ratio of 0.63, and a price/earnings ratio of 14.74, RTR could be considered a value play, and offers exposure to a mixture of developed and emerging regions. UK companies comprise about 17% of RTR; Japan, 14%; and China, 12%. The RevenueShares methodology continues to outperform in many of its other ETFs.
Editor's Note: Max Isaacman is the author of Blizzard of Money, Winning with ETF Strategies, Investing with Intelligent ETFs, How to Be an Index Investor, and The NASDAQ Investor.
The author and/or his customers own shares of DGS, RTR.