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As the Stock Market Stays Strong, Two ETFs to Consider


Plus: Why individual investors should consider using smart-beta ETFs.

Stock markets around the world usually reflect how much global activity is happening, and how much is anticipated. We are likely still in a post-2008 sub-prime crash period, and investors are still cautious. But the post-crash environment is slowly becoming a memory, and "animal spirits" risk-on investment appetites are returning. Higher global economic activity could translate into the stock market's continuing strength.

As John Forlines of JA Forlines Global Investment Management wrote in a recent Advisory Update, "Corporate earnings have been solid, interest rates remain low, and inflation is almost non-existent in most developed countries. Our position remains that the global economy is slowly recovering from the most recent crash in 2008 and risk takers who have allocated some portion of their holdings to corporate bonds and equities are going to be rewarded again this year."

Forlines also points out that none of these facts are in the news very much, because facts like these are not exciting. He remarks that what's more commonly reported is bad news from emerging markets like Turkey and Argentina, and he posits that "what is important is that all the major developed countries/regions are finally in some kind of expansion. And China, despite the bad financial reporting, will be growing once again this year well above the US, Japan, and Europe." Forlines acknowledges that market rates are slowly rising, but rates have a long way to rise before they will have a negative impact on equities and corporate bonds.

Projections suggest that economic growth should be good this year. If these projections are fulfilled, it should be good for stock markets. According to the International Monetary Fund, global activity is projected to be around 3.7% in 2014, up from 3.0 in 2013.

The mix of global activity is also changing. Growth in the US is expected to be 2.8% in 2014, up from 1.9% in 2013; China growth is expected to be 7.5% in 2014, which is down from prior years; growth in Emerging Markets and Developing Economies is projected at 5.1% in 2014, which is up from 4.7% in 2013. These numbers also indicate that the advantage emerging markets have had over developed economies -- namely growth -- has surely shrunk.

US Investors Are Not Expecting Much of a Market Advance

According to a recent Associated Press GfK poll, only 14% of people believe that the market will rise this year, and 5% think it will crash. The other people polled believe the market will stay about where it is, or will drop slightly. Also individual investors are not as optimistic about the stock market outlook as investment professionals are.

There is a disconnect between US investors and the recent market performance: the S&P 500 Index (INDEXSP:.INX) is up about 162% from its low in March 2009, yet the findings of the poll suggest that US investors are wary about the stock market. In the poll 71% say that investing in the stock market is "generally risky," compared with only 27% who say the market is "generally safe."

As pointed out, probably the disconnection between good stock market performance and individual investors' wariness of the market is due to the fact that individual investors are still feeling the effects of the 2008 crash. Investment professionals are generally more experienced in dealing with down markets, and are not as shocked when markets have tough declines. The markets, in an environment such as this, seem poised to climb further up the "wall of worry."

ETFs to Consider

Institutional investors are increasingly using smart-beta ETFs, and with a possible increase in risk appetite as the market climbs, individual investors should consider using them, too. Smart beta is a term used for various quantitative investment strategies that are formulated and then packaged into ETFs and other investment structures. I referred to these ETFs as "Intelligent ETFs" in my book Investing With Intelligent ETFs (McGraw-Hill, 2008). These strategies deviate from cap-weighting methods and use strategies such as equal-weighting and fundamental-weighting methodologies. Smart-beta strategies go beyond cap weighting and embrace sector choices, cap size choices, and other, and often, complicated methods.

Smart beta (or to use the original term "intelligent ETFs") is constructed to beat an index, such as the S&P 500. As such, an intelligent ETF differs from that broad index. Although high-beta intelligent ETFs have the potential of over-performing, they also contain the potential of underperforming, since they deviate from broader indices. An intelligent ETF can underperform the broader indexes for many years, and cause the holder opportunity cost. Also management fees are usually higher in intelligent ETFs, so an investor should know the risks and possible downside with these vehicles.

Among the better-performing high-beta ETFs that investors can consider are the following:

1. The Guggenheim Solar ETF (NYSEARCA:TAN). The underlying fund invests in stocks and stock instruments that replicate the Mac Global Solar Energy Index. The index tracks companies that make solar power equipment for end users, companies that make fabrication products, and other companies, all involved in manufacturing and servicing the solar industry. It a is highly specialized index, containing only 29 names. It also offers international exposure, with 37% of the companies in China, 34% in the US, 10% in Hong Kong, and other overseas countries. The ETF is selling at a high multiple.

2. The PowerShares Nasdaq Internet Portfolio (NASDAQ:PNQI). The Index is designed to track the performance of the biggest and most liquid US-listed companies engaged in Internet-related businesses, and that are listed on a major US stock exchange. Facebook (NASDAQ:FB), Google (NASDAQ:GOOG), and (NASDAQ:PCLN) comprise about 30% of the Index. PNQI was selling at about 38 times earnings at the end of 2013, which is high when compared to the broad market; but the Internet/social networking category is one of the fastest-growing sectors, and many companies are selling at a premium multiple.

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.
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Positions in TAN and PNQI.
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