Speculation of a cyclical rotation was confirmed this year with industrial sector exchange traded funds proving to be a stomping ground of sorts for investors looking to bet on an improving U.S. economy.
The Vanguard Industrials ETF (VIS) is up more than 41% this year and so strong have inflows to industrial ETFs recently been that the Industrial Select Sector SPDR (XLI) has surpassed its health care equivalent to become the third-largest U.S. sector ETF. [Health Care SPDR Jumps Into Third Place Among Sector ETFs]
Yet it is the SPDR S&P Aerospace & Defense ETF (XAR) that currently wears the crown as 2013’s best industrial ETF, though it should be noted XAR is locked in a heated competition with the iShares U.S. Aerospace & Defense ETF (ITA) for that honor.
On its own, the fact that aerospace and defense ETFs have been leading sub-industry plays in 2013 is impressive. Few investors predicted that strength at the start of the year given that group’s vulnerability to government spending cuts. [A Sturdy Industrial ETF]
XAR has been able to muster a gain of over 52% this year even though it is not excessively allocated to the most widely held A&D names, such as Dow components Boeing (BA) and United Technologies (UTX) or Lockheed Martin (LMT). Of that trio, only Lockheed resides in XAR’s top-10 holdings and no stock accounts for more than 4.3% of the ETF’s weight. [Stealthy Aerospace ETF Soars]
One concern with industrials is that they are richly valued. Morningstar says of VIS “VIS currently is trading at 105% of its fair value, while the S&P 500 Index trades at 102% of its fair value. So investors should become comfortable with the valuation before investing.”
XAR, however, trades at a discount to ITA. The former sports a P/E ratio of 18.7 compared to 22.3 on ITA. Catalysts that could lead to further upside for XAR in 2014 include, renewed airline pricing power evidenced by higher ticket prices, and more fees paid per traveler, increased airline profitability, new aircraft program launches and continued demand for aircraft models and technology.
Additionally, XAR is positioned to remain durable as interest rates rise because industrials are among the best sectors in rising rate environments.
SPDR S&P Aerospace & Defense ETF