Tom Lydon’s 2013 ETF Outlook

ETF Trends

Annual forecasts should always be taken with a grain of salt because nobody has the ability to predict where the S&P 500 will be in 12 months unless they make a lucky guess.

That said, I can’t resist making some predictions on the major ETF and market trends I see for 2013.

Part of this exercise is that it allows me to look back at the end of the year to see how right — or wrong — I got things in early January.

So here we go with five predictions:

1. Dividend investing and ETFs won’t die: Dividend ETFs slightly trailed the S&P 500 in 2012 after trouncing the index in 2011. I expect dividend-themed ETFs to turn in another good year in 2013. They aren’t a substitute for bonds because equities are more volatile, but investors need to look elsewhere for income with 10-year Treasuries yielding less than 2%. Yes, the fiscal cliff compromise boosts the dividend tax rate to 20% from 15%, but it’s only for individuals earning over $400,000 a year, or $450,000 for married couples. However, S&P 500 companies paid out cash dividends of $281 billion last year, and the total should rise in 2013 as companies continue to shore up their balance sheets in the wake of the financial crisis. The largest dividend ETFs include iShares Dow Jones Select Dividend Index Fund (DVY), Vanguard High Dividend Yield Index Fund (VYM), SPDR S&P Dividend ETF (SDY) and WisdomTree LargeCap Dividend Fund (DLN). [Three Reasons Not to Flee Dividend ETFs]

2. Most investors are unprepared for rising interest rates: It’s not surprising investors are ignoring the warnings on the dangers of rising interest rates. They hear it every year, and every year the experts are wrong as Treasury yields march lower to extend a 30-year rally in bond prices. Nervous investors have piled into fixed-income mutual funds and ETFs in the wake of the financial crisis. They are set up for big losses if rates rise and bond prices fall in the U.S. Investors can protect themselves somewhat with floating-rate ETFs and funds that invest in international bonds. Emerging market debt ETFs such as iShares Emerging Markets High Yield Bond Fund (NYSEArca:EMHY) and iShares JPMorgan USD Emerg Markets Bond (EMB) are paying attractive yields.

3. China outperforms in 2013: Most of last year was tough for China ETFs such as iShares FTSE China 25 Index Fund (FXI) on economic “hard landing” worries although they have turned on the gas since September. I expect China ETFs to outperform developed markets in 2013 as the global economy continues to improve and Chinese leadership provides more market-friendly stimulus. China ETF Flirts with 52-Week High]

4. 2013 is the year of the commodity ETF: Some agriculture ETFs soared over the summer due to the historic drought, and gold wrapped up its 12 th straight up year in 2012. However, investors in diversified commodity ETFs have been disappointed recently. For example, PowerShares DB Commodity Index Tracking Fund (DBC) has lagged the S&P 500 four straight years. However, the trend could reverse in 2013 if oil and gold heat up, and the U.S. dollar gets pushed lower by U.S. deficits and Federal Reserve stimulus. In any case, a small allocation to commodities can help diversify a portfolio of stocks and bonds.

5. Cyclical sectors outperform: In the U.S., I like the more cyclical sectors such as financials, consumer discretionary and technology heading into 2013. I’m less enthusiastic about traditionally defensive sectors such as utilities and consumer staples. Clearly, this reflects my view that the U.S. economy will continue to improve this year.

Full disclosure: Tom Lydon’s clients own EMHY, EMB, DVY.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.

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