The year 2017 started on a positive note as investors remain hopeful that Trump's policies will result in faster economic growth and higher interest rates. But many investors now worry that the market could be getting ahead of itself.
It appears that the market has already priced in the best case scenario of growth and inflation, leaving a lot of room for disappointment if things do not go as planned. A surging dollar and rising bond yields could also pose headwinds to the market. The surge in dollar would hurt multinationals that derive a significant portion of their earnings from abroad and high rates impact the economic activity and the housing market.
At the same time, there are many other factors that could support the rally this year. One of the strongest tailwinds for stocks could emanate from rotation out of bonds. After the great financial crisis, many investors have remained underinvested in stocks, preferring "safer" bonds.
These investors missed out on one of the greatest stock rallies in history. Per WSJ, the Dow has returned 274%, including dividends, since bottoming out in 2009, while the 10-year Treasury note has returned 33% over the same period. After realizing that the three-decade-old rally in bonds is over now, these investors could return to stocks.
Earning growth could also add fuel to the rally. After five quarters of earnings recession, S&P 500 companies reported +3.8% growth for Q3. Per Zacks Earnings Trends, for Q4 as a whole, total earnings for the S&P 500 companies are expected to be up +3.1% from the same period last year on +3.9% higher revenues.
Over the past few years, share repurchases have been a major force behind the rally. After slowing down earlier this year thanks mainly to stretched valuations, buybacks picked up again after the presidential election. Companies are expected to spend more on buybacks with savings from tax cuts and cash repatriated from abroad under the repatriation tax holiday.
While financials and industrials ETFs soared after the election, below we have highlighted some ETF areas that are likely to shine in 2017.
Dividend Growth ETFs
As growth and inflation are expected to pick up this year, the Fed is expected to raise rates at least a couple times. High dividend ETFs which have been one of the biggest beneficiaries of the ultra-low rate environment tend to underperform when rates rise.
On the other hand, dividend growth ETFs that hold companies with solid balance sheets and rising cash flows, outperform in such environment.
Vanguard Dividend Appreciation ETF (NYSEARCA:VIG), a Zacks Rank#2 (Buy) ETF, focuses on high-quality companies with at least ten consecutive years of increasing dividend payments. Expense ratio is just 9 basis points. Top holdings include Microsoft (NASDAQ:MSFT), J&J (NYSE:JNJ) and Pepsi (NYSE:PEP).
The US dollar, which has been rising since the election, should see further gains ahead if the Fed hikes rates aggressively next year. A strong dollar and improving growth in the US benefit Japanese exporters. The Bank of Japan is expected to continue to pursue its ultra-accommodative monetary policy, which will benefit Japanese stocks and weaken the yen.
Further, Japanese stocks look significantly underpriced compared to the US stocks. WisdomTree Japan Hedged Equity ETF (NYSEARCA:DXJ), currently Zacks Rank#1 (Strong Buy), provides access to Japanese dividend paying exporters, while hedging out the currency risk. Toyota Motor (NYSE:TM), Mitsubishi and Sumitomo Mitsui Financial (NYSE:SMFG) are the top holdings.
Technology stocks, except semiconductor stocks, did not participate in the post-election rally thanks to concerns regarding the impact of Trump's trade and immigration policies. But of late, big tech stocks have been rising, particularly after conciliatory meeting between Trump and the tech leaders.
Technology companies tend to do well when the economic growth picks up. Further, they are expected to be the biggest beneficiaries of repatriation tax holiday. New areas of spending such as Cloud Computing, Internet of Things (IoT) and Autonomous Cars will also drive growth this year. Technology Select Sector SPDR ETF (NYSEARCA:XLK), a Zacks Rank#2 (Buy) ETF, is a low cost and convenient way of getting exposure to S&P 500 technology stocks.
With share repurchases expected to surge this year, thanks to Trump administration's planned tax reforms, PowerShares BuyBack Achievers Portfolio ETF (NASDAQ:PKW) could be an interesting option for investors. Goldman expects total buybacks for 2017 to reach a new record of $780 billion.
The ETF holds shares of companies that have reduced their shares outstanding by 5% or more in the trailing 12 months. McDonald's (NYSE:MCD), Boeing (NYSE:BA) and Qualcomm (NASDAQ:QCOM) are the top holdings in this ETF.
Aerospace & Defense ETFs
Aerospace & Defense companies had soared initially after Trump's win on hopes of a surge in defense spending under the new admiration. However, after Trump's tweets targeting some of these companies, particularly Boeing and Lockheed Martin (NYSE:LMT), their shares had taken a beating. Looking at the longer-term picture, these companies are worth buying at these prices.
Per WSJ, major defense contractors are likely to benefit from US military's increased spending on precision-guided missiles and bombs in its campaign against the Islamic State in the Middle East. Take a look at the Zacks Rank#1 (Strong Buy) iShares U.S. Aerospace & Defense ETF (BATS:ITA).
The product's top holdings include Boeing, United Technologies (NYSE:UTX) and Lockheed Martin.