Market Overview

S&P Upgrades Industrial Sector; Highlights Three ETFs

Amid accommodating monetary policy from the Federal Reserve and the expectation that the global economy will improve slightly next year, S&P Capital IQ has upgraded its view on the industrial sector to Overweight from Marketweight. In a new research note, the firm highlighted three ETFs with which to take advantage of improved sentiment in the industrial sector.

Despite a slight valuation premium for the sector of 12.8 times next year's earnings compared to 12.6 times for the broader market S&P Capital IQ's equity strategy group said it is "encouraged by the Industrial sector's developing favorable technical formation, which they thought could lead to a possible upside breakout."

"We believe it stands to reason that if we see improvement in global GDP and an improved China economy, the Industrials sector should see improved demand for its products and services, which are closely tied to overall U.S. and global GDP growth," said S&P Capital IQ in the note. "An improved global economy would likely lead to more demand for all types of industrial equipment, including construction and manufacturing equipment, as well as increased demand for transportation for all types of goods and services."

At the ETF level, the research firm has an Overweight rating on the Industrial Select Sector SPDR (NYSE: XLI). With an expense ratio of 0.18 percent and $3.6 billion in assets under management, XLI is the largest and least expensive ETF tracking industrial stocks.

Top-10 holdings in XLI include five Dow components – General Electric (NYSE: GE), United Technologies (NYSE: UTX), 3M (NYSE: MMM), Caterpillar (NYSE: CAT) and Boeing (NYSE: BA).

S&P also rates XLI's primary rival, the Vanguard Industrials ETF (NYSE: VIS), Overweight. While VIS has a top-10 lineup that mirrors XLI's, it is home to 369 stocks compared to just 62 in XLI. VIS is slightly more expensive than its SPDR rival with an annual expense ratio of 0.19 percent. However, VIS has sharply outperformed XLI on a year-to-date basis with a gain of 16.3 percent compared to almost 12.9 percent for the SPDR fund.

S&P is also bullish on the iShares Dow Jones Transportation Average Index Fund (NYSE: IYT), which it also rates Overweight. The $555 million ETF is the largest devoted to the transportation sub-sector. IYT allocates 29.5 percent of its weight to railroad operators including Union Pacific (NYSE: UNP), Kansas City Southern (NYSE: KSU) and Norfolk Southern (NYSE: NSC).

Exposure to railroads and shipping firms does give IYT some correlation to a recovering global economy, but the ETF is pricey relative to the broader market. IYT's price-to-earnings ratio is 16.65 and its price-to-book ratio is 3.76, according to iShares data.

For more on ETFs, click here.

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