Boring may be beautiful for investors as economic recovery matures


There are signs that investors are shying away from highflying technology and momentum stocks in favor of classic industrial-sector names such as General Electric (GE) and Caterpillar (CAT) as the bull market matures.

Bloomberg reports that industrials have the fastest earnings growth in the market, while Industrial Select Sector SPDR ETF (XLI) has seen the largest five-day inflow since it launched in 1998.

XLI Chart

XLI data by YCharts

Sectors that have outperformed the overall market since the financial crisis such as retail and biotech have taken some of the biggest hits over the past month. Could this perhaps mark the beginning of a sector rotation among institutional investors?

Bill DeShurko owns XLI, the industrials ETF, in the Seasonal ETF Growth portfolio on Covestor.

“I own XLI mostly from a tactical standpoint,” DeShurko said. “The market has been obsessed with highflying tech stocks with little or no earnings. Now, it seems the market is focusing more on fundamentals, and that along with potentially lower interest rates could be good for industrial companies.”

“You’re seeing the beginning of investors shifting money ahead of a wave of spending,” said Drew Nordlicht, managing director and partner at HighTower Advisors, in the Bloomberg report. “The expectation is, as the economy begins to kick into a higher gear, corporate America will utilize the amount of cash to spend on capital expenditures. The industrial [sector is a] direct beneficiary of that.”

XLI, the industrial sector fund, has performed inline with the S&P 500 so far this year. The ETF experienced a record five-day inflow of more than $600 million to start April, marking a reversal from the first quarter when investors yanked $1 billion from the portfolio, according to Bloomberg.

“It’s a good sign that investors are selling some of the more speculative stocks and re-investing in real-world companies,” said Jim McDonald, chief investment strategist at Northern Trust, in the report. “A market that’s led by very, very expensive stocks is less comforting to me than one that’s led by tried-and-true industrial.”

The industrials sector could benefit from manufacturing growth in the U.S. and Europe.

Many of the holdings in the industrials ETF have significant sales outside of the U.S, giving XLI exposure to global growth trends, according to a Morningstar analyst report on the fund

“At the same time, the U.S. industrials sector is exposed to a meaningful amount of cyclicality. That cyclicality, coupled with this ETF’s narrow sector focus, makes this ETF more volatile than other, broader ETFs. Over the past 10 years, XLI has had a volatility of return of 18.7% compared with 14.6% for the S&P 500,” writes Morningstar analyst Robert Goldsborough. Volatility measures the tendency of a security to fluctuate in price.

Yet as the economic recovery continues, “many of the late-cycle firms in this ETF should shine,” Goldsborough added.

Photo credit: owakulukem via Flickr Creative Commons

DISCLAIMER: The investments discussed are held in client accounts as of March 31, 2013. These investments may or may not be currently held in client accounts. The reader should not assume that any investments identified were or will be profitable or that any investment recommendations or investment decisions we make in the future will be profitable. Past performance is no guarantee of future results.