Looking ahead to 2017, there’s one thing investors can be sure of: no one knows anything.
Will the stock market continue minting records (and will the Dow finally surpass 20,000), or will the multiyear bull market get slaughtered? What impact will it have on the economy if the Federal Reserve does what it recently implied and raises interest rates three times next year? Is the optimism that traders have over President-elect Donald Trump justified, or will the “Trump rally” go the way of Trump Steaks?
While most expect passive investing to continue to be favored over active, other trends are up in the air. In such an uncertain environment, here are a few exchange-traded funds that investing experts picked for the coming year. The choices span the market, looking at different regions, sectors, and asset classes. Given the infinite number of ways the market could move next year, they may not all pay off, but all are worth keeping an eye on.
Sector calls: Banks and Natural Resources
Energy XLE, -0.20% and financial stocks were the biggest gainers of 2016, with the former jumping about 25% thanks to a long-awaited recovery in crude oil prices. Gains in the latter—up nearly 20%—were concentrated in the final weeks of the year, with banks soaring after the election as investors bet that the group would benefit from the dual tailwinds of rising interest rates and industry deregulation, which is expected to be supported by the incoming administration.
Both of these upward trends are expected to continue in 2017, with the most popular financial ETF cited by multiple analysts: the Financial Select Sector SPDR ETF XLF, -0.73%
“Rising interest rates and reduced regulatory headwinds support a continuation of the financial services industry’s relative strength,” said Jay Batcha, founder and chief investment officer of Optimal Capital.
This selection was seconded by Jason Browne, chief investment officer of FundX Investment Group, who added that “the potential for reduced regulation could relax lending standards, improving margins further, and opening up M&A potential.”
Browne also named the SPDR S&P Regional Banking ETF KRE, -0.84% a narrower investment thesis that focuses on regional banks, as a 2017 pick. “Regional banks are the sweet spot because they benefit from improved interest rate margins and relaxation of some of the regulations when they were being lumped in with bigger banks,” he said. The fund has gained 32% in 2016.
Counterpoint: Why big banks might have the edge as financials soar
On the commodity side, Batcha named both the VanEck Vectors Natural Resources ETF HAP, +0.68% and the SPDR S&P Oil & Gas Exploration & Production ETF XOP, -0.64% as investments for 2017. “Sustained stability in energy prices should stimulate pent-up drilling activity,” he said. The VanEck fund is up 23% thus far this year, while the SPDR ETF has surged about 38%.
Batcha also picked another 2016 favorite going into 2017: the VanEck Vectors Junior Gold Miners ETF GDXJ, +9.23% which focuses on small-cap gold and silver miners. The fund is up more than 70% this year, far outpacing the 8.6% rise of the SPDR Gold Trust GLD, +1.31% but he sees the gains continuing because it “provides lots of leverage to higher gold prices, which should be supported by increasing global inflation rates and resurgent developing economies.”
Strategy Funds: Value
If 2016 was the year of high-yield, as investors flocked to dividend-paying funds in search of yield, then 2017 could be the year of value.
Browne named two funds with a value tilt—the small-cap iShares Russell 2000 Value ETF IWN, +0.09% and the iShares S&P Mid-Cap 400 Value ETF IJJ, +0.25% which focuses on relatively larger companies—that he expects will give investors good bang for their buck in the coming year.
“We have seen a rotation from large cap growth to small and midcap value and these rotations tend to persist for years,” he said. “Some of the attention may be due to a domestic focus and less dependence on global trade, but the value focus is also being rewarded as investors are concerned that the broad market may be fully valued.”
He described the Russell 2000 fund as “aggressive,” and the midcap ETF as a core holding, noting that stocks with a medium market cap, compared with their smaller equivalents, are “stronger, more established companies and therefore tend to be less volatile.”
Batcha stuck with the dividend theme, but rather than picking traditional dividend funds—which remain in demand despite a recent selloff in bonds—he opted for the Reality Shares DIVCON Dividend Guard ETF GARD, +0.00% an actively managed ETF that aims to provide exposure to large-cap stocks that are expected to increase their dividends.
The bond market may see more action than the equity market next year as investors grapple with an environment that, for the first time in years, promises to offer something other than rock-bottom rates.
As protection against any fixed-income volatility, Bill Belden, head of ETF business development for Guggenheim, advocated for his own firm’s suite of BulletShares ETFs. The funds are fixed-term products that provide exposure to defined-maturity bonds, meaning that they are designed to liquidate by a set time, at which point they will be 100% cash.
Because most bond funds are open-ended, Belden said, “they don’t really align with the changing needs of investors, let alone the market itself. If you put your investment into a product that aligns with your timeline, on the other hand, and you hold it until maturity, then rising rates shouldn’t be punitive.”
Also in the fixed-income space, Browne cited the First Trust Low Duration Opportunities ETF LMBS, -0.02% an actively managed fund that invests in mortgage-based securitized instruments with a target duration of less than three years.
The fund “has done a good job navigating a challenging environment that has seen volatile shifts in interest rates and yet doesn’t take significant credit risk like bank loan funds,” he said. “A fund like this offers diversification and compelling performance potential as part of a fixed income allocation.”
The fund is up 3.4% in 2016.
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