Choose ETFs With Relative Strength As Well As Defensive Attributes

Includes: PJP, RTH
by: Gary Gordon

The U.S. economy's modest growth is attributable to the real estate market, corporate debt restructuring and big ticket consumption like auto. All of these areas are extremely rate sensitive. It follows that, with the Federal Reserve "taper talking" 10-year yields higher by 100 basis points (1%), the U.S. economy should slow in the coming months. In fact, the International Monetary Fund essentially confirmed the probability of the slowdown with a downward GDP revision from its April assessment.

Yet none of this seems to be hindering exuberance for U.S. stocks. Is this because six months of jobs data have been genuinely impressive? Is this because the Fed expressed a belief that the U.S. economy is gaining in strength, even as the IMF pours cold water on the notion? It seems the real truth on U.S. stock gains rests somewhere in between. The reality is that the global investing community often weighs the pros and cons of alternatives. And right now, all competing investments seem to lack appeal.

Consider just how harshly rising interest rates stateside adversely impacted foreign yield producers. Market Vectors Emerging Market Local Bond (NYSEARCA:EMLC) and SPDR DJ Wilshire International REIT (NYSEARCA:RWX) witnessed top-to-bottom declines of roughly 14% and 18% respectively. The possibility of Fed tightening has resulted in 3-year highs for the dollar, helping to obliterate a currency proxy like SPDR Gold (NYSEARCA:GLD); the same prospect of tightening via tapering has cremated U.S. bond proxies like iShares 20-Year Treasury (NYSEARCA:TLT). The IMF's downward revision of emerging market economic output gives reason for more investors to flee funds like iShares Emerging Markets (NYSEARCA:EEM); meanwhile, slower global growth hits commodities across the board, where funds like PowerShares DB Commodity (NYSEARCA:DBC) have been decidedly impotent.

Something certainly has to give. Either U.S. stocks are going to buckle under the weight of the global growth slowdown, higher interest rates and tepid corporate revenue, or U.S. stocks will continue to thrive as the safer haven capital price appreciator. History suggests that when an area becomes saturated with admirers (e.g., dot-com tech, real estate, oil, emerging markets, Apple (NASDAQ:AAPL), etc.), there's an inevitable stampede for the exits. That said, history cannot discern whether a stampede is 3 days, 3 weeks, 3 months or 3 years away.

The rotation out of different asset types is rooted in higher interest rates rather than a recognition of attractive price-to-earnings ratios for S&P 500 corporations. P/Es at 1650 for the S&P 500 may be fairly priced, but they aren't a screaming bargain either.

Even areas that have been beaten down by the Fed's discussion of tapering may not be low enough for bargain hunting. Take SPDR Homebuilders (NYSEARCA:XHB). The technical uptrend (200-day MA) coupled with "higher lows" might indicate another run-up from present prices. On the other hand, interest rates that are 1% higher may be an issue for forward P/Es of 19.

Fundamentals are not driving this bull rally in U.S. equities; rather, the unattractive nature of the alternatives are making U.S. stocks look handsome. In my estimation, the best way to participate in a momentum market (should you choose to do so) is to sprinkle in sectors that have relative strength as well as defensive qualities. Two of my favorites? Market Vectors Retail (NYSEARCA:RTH) and PowerShares Dynamic Pharmaceuticals (NYSEARCA:PJP).

Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.