Industrial ETF’s Flex Their Muscles

By Brian O’Connell (June 2011)

With the economy seemingly on a slower pace, if not stalled out completely, anxious Americans – and anxious investors – are turning back to basics.

That means more buying more consumer staples, more bonds, and more consumer industrials.

That’s right  – industrials. Stocks like John Deere (Stock Quote: DE), IBM (Stock Quote: IBM), and 3M are in demand as investors seeks solid, stable “safe havens”. The industrial sector, includes agricultural, manufacturing, and commodity producers, leans heavily on consumer confidence, which hasn’t exactly robust lately.

But if you read between the lines, consumer spending (which has slowed is really just being diverted from luxury items like vacations and BMW’s, and toward consumer basics, like food, small appliances, and commodities.

Plus, corporations are making big bucks overseas, especially in emerging markets, and need higher-end industrial products like steel, iron, machinery, and other industrial staples.

If you can’t decide between a John Deere or a 3M, make it easy on yourself by buying into an industrial ETF. Big ETF’s like the Market Vectors Agribusiness (MOO) and the SPDR Industrial Select Sector Fund (Stock Quote: XLI)  (which both hold big positions in Deere) enable investors to buy a basket of industrial stocks, at value prices, with complete trading liquidity and lower management fees than through a traditional broker or mutual fund.

Most industrial ETFs offer fees in the 0.50% range, compared to 2%-or-3% for mutual funds. The tax implications of buying into an ETF are minimal, especially when compared to stocks and mutual funds, which can carry high capital gains taxes when investors sell out at a profit.

Mostly, though, investors come for the stock performance, and stay for the ancillary benefits like lower fees, easier liquidity and more favorable tax treatment.for

So why industrials – especially in an economy that is tossing jobs around like manhole covers? Surprisingly, the products that the industrial sector produces – like agricultural goods and construction equipment, are in fairly high demand.

Industrial Plant

According to data from Jefferies Equity Research, the industrial sector is picking up for two big reasons:

  • Crop prices remain high with margins higher than expected, due to strong pricing and productivity. (And) crop prices may remain elevated relative to historical averages.
  • A pick-up in construction sales and non-agricultural farming re-accelerates.

Another big reason for industrial ETFs – growth and demand in emerging markets. Countries like India, Brazil and South Africa are actually demonstrating strong economic growth, especially among their burgeoning middle classes. Consumers in emerging markets are demanding more houses, more computers, and more food and farm goods. That has led to rebound for U.S. manufacturers, who are generating stronger balance sheets and who are actually bullish on earnings for the rest of 2011 and into 2012.

That goes companies like AGCO (Stock Quote: AGCO), where CEO Martin Richenhagen says that growth in Brazil is near “record levels”. Cummings (Stock Quote: CMI) is another high-flyer overseas, showing a profit of .75 cents per share when analysts expected 35 cents a share in the first quarter. Then there’s the aforementioned 3M (Stock Quote: MMM), which recently announced that sales in the Pacific Rim were up 54% during Q1, which outpaced analyst estimates by 10%.

Some analysts are pulling back on showing too much optimism for industrials, but any slowdown should be temporary.

Says David Resler, chief economist with Nomura Securities, “We expect softness in the (most recent durable goods order) number resulting from supply disruptions in the auto industry affecting other industries. These broken supply chains should have only transitory effects, and that this decline is not part of a larger trend.”

What are some of your best choices when choosing an industrial ETF? Here’s our vote for some of the more promising funds:

iShares Dow Jones U.S. Industrial (Stock Quote: IYJ). This iShares holds big industrial companies like 3M (3.3%), Caterpillar (3.3%) and General Electric (11.2%). Total assets are at $512 million, and year-to-date returns clocks in at 9.06%. Long-term results are spottier, at 4.26%.

Industrial Select Sector SPDR (Stock Quote: XLI). This ETF also holds 3M (at 3.5% of the portfolio), along with a healthy position in IBM (3.5%). XLI has about $4.2 billion in assets, and has returned 8.4% in year-to-date returns through mid-June. At 0.20%, the fund’s expense ratio (its annual fee) is one of the lowest in the ETF marketplace.

Vanguard Industrials ETF (Stock Quote: VIS). The Vanguard ETF, like the iShares Fund, holds a huge position in General Electric (Stock Quote: GE) at 12.2%. UPS, (Stock Quote: UP)), Boeing (Stock Quote: BA), and Honeywell also populate the fund; making it one of the most “pure” industrial ETF plays in the sector. Year-to-date returns are competitive with its class – at 8.02%. The fund holds $578 million in total assets.

Ultra Industrials Pros hares (Stock Quote: UXI). UXI is peppered with many of the industrial favorites listed above: GE is the mainstay, comprising 7,22% of the fund. Caterpillar, UPS, and Union Pacific (Stock Quote: UNP) combine for another 5.6% of the fund. After a horrible start – the fund posted losses of 9.1%, on average, over the past three years. But it’s 2011 year-to-date totals amount to 17.2%, making it one of the best in the industrial ETF class.

In a precarious economy, industrial ETFs seem to be holding up well. Even as other economic indicators point to slowed growth for the U.S., key industrial index like orders, inventory and exports are good indicators that manufacturing, at least on a global basis, is poised for growth – especially when the global economy really takes off.

With investors increasingly spooked by their own shadows, industrials offer more patient investors a chance to ride out the economic slide, and take full advantage of market upswings, just as millions of other investors head to the sidelines.

That seems like a good bet in an anxious market.