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The Dow Jones (NYSEARCA:DIA) and S&P 500 (NYSEARCA:SPY) have attained new highs and as headlines from foreign markets intimidate investors and hawks escape the bond markets many have sought protection in lieu of opportunity. Two sector ETFs have missed the resulting capital inflows and now represent greater opportunity and better protection than its outperforming counterparts. Basic Materials (NYSEARCA:XLB) and Industrial (NYSEARCA:XLI) ETFs have been left for dead but as other ETFs become overbought, these two now stand recover nicely.

Fed Chairman Ben Bernanke and the Federal Open Market Committee recently reassured US equity holders with dovish statements about the continuation of economic stimulus despite a growing economy. Per the March 20th, 2013 FOMC statement:

'To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee decided to continue purchasing additional agency mortgage-backed securities at a pace of $40 billion per month and longer-term Treasury securities at a pace of $45 billion per month. . . To support continued progress toward maximum employment and price stability, the Committee expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the asset purchase program ends and the economic recovery strengthens'

Because of the US Central Bank's accommodative stance, many credit Bernanke for the stable environment in which stocks have posted gains over the past four years. However, many economic indicators such as job growth, housing and automotive industry improvements pointing to a stronger economy have been a cause for concern regarding the end of stimulus; naturally, the FOMC statement effectively eased these concerns. In fact, investors have shrugged off many other concerns as well, including sequester cuts, Cyprus bailout issues, and major resistance at the all-time highs recently reached by the ETFs representing the Dow Jones Industrial Average and S&P 500 . While periods of low volatility can last a long while, many see volatility this low as a precedent to a major correction yet the market has continued to leave them behind.

The Fed support cannot be dismissed as this market has held course throughout the stimulus period despite many obstacles, as stimulus continues the market's bull case remains strong. So many have been calling for a correction since November 2012, but increasing capital inflows into US equities have more than offset slowing earnings. Slowed earnings may be just another example of buying opportunities as the Bernanke Bull market continues onward and upward. Despite broad gains year to date in the SPY there have been imbalances among small and large cap stocks. Chart forSPDR S&P 500 (<a href=

The chart shows a recent spike which indicates how the broad market is beginning to rally against small cap stocks represented by the S&P Small Cap Index ETF (NYSEARCA:IJR).

While a rotation from small cap back to large cap stocks can be interpreted as a defensive maneuver for investors, the rotation may be better described as a transition from other assets to equities, specifically large cap stocks. Though the Federal stimulus continues, many are avoiding bond exposure and the inevitable interest rate increase from a Fed stimulus conclusion and getting invested into safe, well-known large-cap securities. The recent inflows to equities seem to not only forsake small-cap stocks but investors are bypassing Industrial and Materials ETFs as well. These charts below represent the sectors against the S&P 500 and it is plain to see that the index has recently outperformed the XLI and the XLB. Investors have shunned these sectors in the wake of recent Cyprus banking concerns for the pursuit of 'defensive' sectors, based on the bull case for the broad index stated at the beginning of this article investors could be missing great opportunities in these sectors as they push other areas that make up the SPY to overbought levels.

The chart shows a recent spike which indicates how the broad market is beginning to rally against small cap stocks represented by the S&P Small Cap Index ETF (IJR).

While a rotation from small cap back to large cap stocks can be interpreted as a defensive maneuver for investors, the rotation may be better described as a transition from other assets to equities, specifically large cap stocks. Though the Federal stimulus continues, many are avoiding bond exposure and the inevitable interest rate increase from a Fed stimulus conclusion and getting invested into safe, well-known large-cap securities. The recent inflows to equities seem to not only forsake small-cap stocks but investors are bypassing Industrial and Materials ETFs as well. These charts below represent the sectors against the S&P 500 and it is plain to see that the index has recently outperformed the XLI and the XLB. Investors have shunned these sectors in the wake of recent Cyprus banking concerns for the pursuit of 'defensive' sectors, based on the bull case for the broad index stated at the beginning of this article investors could be missing great opportunities in these sectors as they push other areas that make up the SPY to overbought levels.Chart forS&P 500 (^GSPC)

Chart forS&P 500 (^GSPC)

The investors that have forsaken the Industrials and Basic Materials seem to embrace Consumer staples (NYSEARCA:XLP) and Healthcare stocks (NYSEARCA:XLV). The charts below show how investors that bought XLP and XLV or their holdings leading into Q2 profited as those securities moved up against the S&P 500 even as that index hit all-time highs. The market has been shrugging off bad news throughout the bull-market and now that the hard line of resistance has been met (although not tested), many believe that the SPY could easily move beyond 1600. The cause for the move to XLP and XLV stem from the belief that their holdings are more defensive against headline risk from Europe and China than the XLI and XLB and these ETFs' holdings.

Chart forS&P 500 (^GSPC)

Chart forS&P 500 (^GSPC)

Now that XLP & XLV companies have made their moves, new investors in these spaces could be late to the party. The XLP is most heavily represented by its holdings of Procter & Gamble (NYSE:PG), Phillip Morris (NYSE:PM), Coca-Cola Co (NYSE:KO) and Wal-Mart (NYSE:WMT) which have pushed the fund up 9.2% YTD. Similarly, Johnson & Johnson (NYSE:JNJ), Pfizer Inc (NYSE:PFE), Merck & Co (NYSE:MRK), and Amgen Inc (NASDAQ:AMGN) which are the top holdings for the XLV, have led to more than a 8.7% gain for the fund. The concern for new and current investors in these sectors is continued rotation. As the relative strength continues to increase, investors should be wary of how overbought these funds have become. The RSI for the XLP is over 90 and for the XLV it is over 87; even though these are thought of as defensive sectors, these levels quite possibly represent a cautionary signal to take profits or at least wait for a pullback before proceeding with a long position.

Alternatively, the XLI may offer more upside primarily because of the attention the XLV and XLP have already received over recent weeks. The XLI is represented by its top holdings of General Electric (NYSE:GE), United Technologies Corp (NYSE:UTX), Union Pacific Co (NYSE:UNP) and 3M Co (NYSE:MMM) and these companies have provided strength for the fund YTD, up over 8.1%. The XLI is not as overbought as the XLV and XLP; the RSI for the XLI is just over 37, indicating it is near oversold levels.

The XLB is up YTD but not near the levels in the other sector ETFs mentioned, the XLB is up just under 2.5% YTD and may represent the most forsaken ETF. The top holdings for the XLB are Monsanto Co (NYSE:MON), Du Pont (NYSE:DD), Dow Chemical Co (NYSE:DOW), and Praxair Inc (NYSE:PX) which have disappointed relative to the other sectors but the downtrend recently may be over-exaggerated as the fund is oversold with an RSI of just 29.

If investors have not learned by now that fighting the Fed is a fruitless effort, then short positions in the XLB and XLI may prove financially painful. As the broad market continues its low volatility bull-run, it would be more appropriate for any investor with a long position to consider buying protection through the short-term volatility index ETF (NYSEARCA:VXX). The companies mentioned are large cap stocks that stand to benefit from asset allocation rotation to U.S. equities and while I expect long positions in general will enjoy the broad economic benefits of Federal stimulus, large cap Industrial and Basic Material stocks will especially benefit from new cash inflows.

Despite recently lagging the market, the value within the XLB and XLI will become more attractive as investors avoid crowds in the XLV and XLP. Based on the macroeconomic bullish case for markets and current RSI levels, investors should look to Industrials and Basic Materials during their recent underperformance for long positions as they offer greater upside potential as well as better downside protection relative to their Healthcare and Consumer Staple sector counterparts.

Disclaimer: I am not a professional advisor; my interpretations of the market are independent and should not be construed as investment advice

Source: 2 Neglected Sector ETFs Set To Outperform