Many investors will be sorry to see 2009 end. Following one of the most disruptive years in recent memory in 2008, almost every asset class participated in a stellar recovery this year. At the depth of the recession, fear trumped reason, and irrational anxieties pushed many assets, including ETFs, well below their intrinsic value. Much of the final three quarters of the year was spent recouping these losses, much to the delight of those who had the wisdom to identify an exaggerated downward correction and the stomach to stay all in as prices bottomed out.
Now, with 2010 just around the corner, the hard work begins. The low-hanging fruit has been collected, and the road ahead is littered with daunting obstacles, ranging from still-rising unemployment to inflation concerns to international debt crises. That’s not to say that 2010 won’t be another stellar year, just that more concrete evidence of a progressing recovery will be needed to push prices higher. “Less bad” news can only be dressed up as signs of improvement for so long.
As we look ahead to 2010, there are a number of bright spots in the ETF industry. Below is a look at ten funds we think present compelling cases for investment in the new year:
1. SPDR Russell/Nomura Small Cap Japan ETF (NYSEARCA:JSC)
Japan was perhaps the only global economy to miss out on the bull market of 2010. Stimulus plans have failed to have the desired effect, and the country faces falling prices, rising unemployment, and a host of other factors that threaten to result in another “lost decade.” Most Japan ETFs eked out single-digit gains in 2009, lagging badly behind the rest of Europe and even other developed economies.
But amidst the doom and gloom are reasons for hope in Japan. Factory output recently logged its ninth consecutive month of growth, with November results up 2.6% from October results. The dollar’s recent recovery has come at the expense of the yen, and a cheaper currency promises to give a boost to the country’s export market, a critical part of the economy. Moreover, the government remains committed to spurring economic growth, recently rolling out another stimulus plan designed to revive a sputtering economy.
Most Japanese ETFs are tilted towards mega-cap Japanese stocks like Toyota (NYSE:TM), Honda (NYSE:HMC), Sony (NYSE:SNE), and Mitsubishi (OTCPK:MMTOF). While these companies are domiciled in Japan, their operations are global in scope, and paths can depend as much on the health of the U.S. economy as the local environment. JSC offers exposure to the “real Japan,” tracking an index with a median market capitalization of just $230 million. If Japan finally arises from its economic slumber, JSC could lead the charge higher.
2. WisdomTree Dreyfus Emerging Currency Fund (NYSEARCA:CEW)
Low interest rates have been one of the keys to the recovery efforts in the U.S., and all indications are that record-low rates are here to stay, at least through the first few quarters of 2010. While much of the developed world is in the same boat as the U.S. — not yet on stable enough ground to begin raising rates — emerging markets are another story. Several developing economies are currently paying money market rates in excess of 7%, staggeringly-high rates for investors accustomed to returns on fixed income investments below 1%.
CEW invests in a basket of money market funds in emerging markets, ranging from South America to Eastern Europe to Asia. Protection against a further drop in the U.S. dollar is an added benefit of CEW (although this obviously comes along with the risks posed by a strengthening greenback). Although this looks, smells, and sounds like a currency fund, it is perhaps more appropriate to think of CEW as a fixed income investment that features currency risk as well (read more about CEW and other short dollar ETFs in this feature, and sign up for our free ETF newsletter for more actionable ETF investment ideas).
3. SPDR Barclays Capital High Yield Bond ETF (NYSEARCA:JNK)
Another alternative to the depressingly-low interest rates offered by most domestic fixed income funds also entails taking on a bit more risk. Junk bonds enjoyed big gains in 2009, but JNK is still almost 10% below levels touched in August 2008.
While most companies appear to have come through the downturn unscathed, some are still saddled with staggering debt burdens. The list of debtors to JNK doesn’t exactly instill confidence: debt from Harrah’s, AIG, and GMAC are among the largest holdings in this bond fund.
So what’s to like about JNK? An average coupon of 9.1% and a yield to maturity of 9.6%, for starters. While this return is far from risk-free, it crushes the measly yields offered by Treasuries (which also seem less than risk-free given the current balance sheet of their issuer). JNK has no chance of becoming the next four-bagger — in fact an annual return over 10% is probably unlikely — but it offers the most bang for your fixed income buck.
4. Utilities Select Sector SPDR Fund (NYSEARCA:XLU)
Not all sectors participated equally in the 2009 rally, just as not all were equally hammered during the downturn. The utilities SPDR found itself near the back of the pack in 2009, lagging behind its technology counterpart by a whopping 40%. This may make XLU an attractive option for investors looking to find the few remaining bargains in the market.
XLU has a forward-looking price-to-earnings ratio of just 13.4, almost 20% lower than the same metric for S&P 500 ETFs and 25% lower than XLK. While this relationship isn’t necessarily surprising (utilities generally have lower long-term growth prospects than the broad market), it makes XLU an intriguing option for investors looking for low risk, defensive equities.
5. IndexIQ CPI Inflation Hedged ETF (NYSEARCA:CPI)
Inflation has been on the minds of investors recently, as the long-term reality of injecting billions of dollars into the U.S. financial system begins to set in. Although price increases have been modest to date, many experts believe that a surge in inflation is inevitable, and that CPI could come in well above the high end of the Fed’s comfort zone, perhaps even pushing double digits.
Among the “inflation bugs,” opinions are mixed as to the best protection. Hedge fund manager John Paulson thinks gold is the answer, while others point to oil, agriculture, and inflation-protected bonds as the best medicine. ETFdb Pro investors can see our play for combating inflation in the Black Swan Hyperinflation Model Portfolio.
CPI seeks to deliver a real return above the rate of inflation as measured by the Consumer Price Index. But CPI is not limited to any one holding, and in fact has the ability to invest in multiple asset classes, including equities, bonds, commodities, and currencies. The index underlying CPI is a rules-based benchmark that will be rebalanced once a month. Currently, CPI’s major holdings include short-term Treasuries (SHV and BIL), long-dated Treasuries, and gold, but this asset mix can shift on a monthly basis to adapt to changing economic conditions.
Again, CPI likely won’t skyrocket in 2010, but if inflation rears its ugly head it could be effective in delivering real returns.
6. Global X FTSE Nordic 30 ETF (NYSEARCA:GXF)
As the calendar turns to 2010, perhaps the most alarming signs of weakness in the recovery are appearing in Europe, where the European Commission recently warned that public finances in half of the 16 euro-zone nations are at high risk of becoming unsustainable. “Governments will spend the next year and beyond balancing the urgent need to fix public-sector debt and deficits — without imperiling what appears to be a feeble economic recovery,” writes Terence Roth.
Greece and Spain have already been downgraded, and Ireland and Portugal could be next. Even the UK and France are vulnerable to deteriorating fiscal situations. The one euro zone country deemed to be a low risk was Finland, which is on relatively solid ground, along with Nordic neighbors Sweden, Denmark, and Norway. These four markets are represented by GXF, which has added more than 10% since its launch in August.
Investments in Europe are risky now, but GXF appears to be in much better shape than most European ETFs.
7. iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA:VXX)
Another of the funds to miss out on the bull market of 2009 has been VXX, which tracks a futures-based strategy of investing in futures contracts on the CBOE Volatility Index, better known as the VIX. This ETN has shown a remarkably strong negative correlation with stocks, gradually retreating as the likelihood of a double dip receded.
After soaring above 80 at the height of the financial crisis, VIX has now dropped below 20. The index still has a ways to fall before hitting levels touched as recently as 2007, but the likelihood of at least a temporary spike seems high.
VXX isn’t an unconditional buy, and it should account for a relatively small part of any investor’s portfolio. But it seems overwhelmingly likely that we will encounter some bumps in the road in coming months that could send hibernating equity markets into a frenzy. For investors looking to pick up some “portfolio insurance,” a 5% (or less) allocation to VXX could be a good idea. For more reading on the VIX, and ways to invest in the “fear index,” VIX And More provides some excellent resources.
8. Dow Jones Emerging Markets Financials Titans Index Fund (EFN)
Emerging markets equities were one of the biggest stories of 2009, as developing economies rebounded from the downturn much more quickly than the developed world. Even after a huge run-up in prices, emerging markets ETFs are still appealing heading into 2010, and EFN in particular has huge potential.
The case for emerging market financials is relatively simple. China, India, and other developing countries are undergoing urbanization at impressive rates, providing financial institutions in these countries with a steady stream of new customers. As citizens of emerging economies take up non-agricultural employment, the middle class will begin to swell, increasing demand for credit to buy homes, automobiles, and other goods that are currently out of reach for much of the population. Moreover, the large scale movements from rural areas into cities necessitates massive infrastructure spending in the developing world, providing an opportunity for banks to offer financing. Finally, most emerging markets' financial institutions maintain balance sheets free of toxic debt, which offers significantly more flexibility than domestic banks.
Another aspect of EFN (and all ETFs from Emerging Global Shares) that we find appealing is the strict definition of emerging markets — the “quasi-developed” economies of South Korea, Taiwan, and Israel aren’t given any weighting in these funds, which focus instead on the BRIC economies.
9. Market Vectors Gaming ETF (NYSEARCA:BJK)
After being battered and bruised during the economic downturn, the gaming industry bounced back with an impressive performance in 2009. But BJK still remains well below highs from the previous year, as consumers have been slow to loosen the purse strings for clothes, let alone craps. But there’s a lot more to the gaming industry than the Las Vegas Strip.
While trips to Sin City are way down, local gaming operations continue to thrive and draw record crowds. And then there’s the tricky little issue of budget shortfalls: unemployment may have technically halted its climb, but a 10% jobless rate translates into a huge decline in revenue for state and local governments. As the realization that these payroll taxes aren’t coming back any time soon sets in, legislators are being forced to get creative with their budgets, and gambling revenues become more and more tempting.
A handful of U.S. states are currently considering legalizing certain types of gambling to fill fiscal deficits, moves that could boost demand for producing of gaming machines and technology.
10. PowerShares Global Listed Private Equity Portfolio (NYSEARCA:PSP)
PSP is one of the more unique ETFs available to U.S. investors, offering exposure to private equity firms that in turn offer exposure to a wide variety of privately-held companies. This ETF invests in between 40 and 60 publicly-traded private equity companies, including business development companies and other financial institutions whose principal business is to invest in and lend capital to privately-held companies. PSP invests in companies around the world, allocating only about 36% of its holdings to U.S. companies.
Many private equity firms were burdened with significant debt over the last two years, and had little flexibility to make deals. But those with cash on hand and the ability to secure financing were able to follow the now-famous Buffett maxim — being greedy when others were fearful. We are at the tail end of one of the best buyers’ markets in decades, and private equity firms that went bargain hunting during the recession may be about to see their efforts rewarded.
Author's disclosure: No positions at time of writing.