ETFs To Play On A Manufacturing “Renaissance” In The U.S. [Vanguard Industrials ETF]

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May 21, 2014 4:08pm NYSE:FXR NYSE:RGI

manufacturing growthThe U.S. Industrial sector is due for a trend reversal this year mainly to reflect the reduced wage differential between developed and emerging economies. It is widely believed that North America and Western Europe are high-cost nations

and Latin America, Eastern Europe, and most of Asia — especially China — are low cost destinations. However, the rising wages in emerging countries and sluggish rise in hourly wages in developed nations have gradually been filling the gap.

This has given birth to the trend of ‘reshoring’ which basically means the return of manufacturing hubs to the U.S. BCG’s latest reports shows that steep wage rises in emerging nations, sluggish productivity growth, strengthening of the U.S. dollar against a basket of emerging currencies and a sharp rise in energy costs in those nations have marred the appeal for offshoring activities.

Narrowing Wage Differential

At the time of the launch of its Industrial Renaissance ETF (AIRR) this year, First Trust provided some data issued by the Economic Policy Institute which says, during the crucial recession period of 2007 to 2012, wages in the U.S. declined for the bottom 70% of U.S. workforce despite productivity expansion of 7.7%.

Average hourly earnings in the U.S. are currently rising at a pace of less than 2%while China – one of the greatest manufacturing offshoring destinations – saw wage increases of about 10.7% last year and looks to log another 10% or more rise in wages this year.

Minimum wages should rise until the mark of 40% of average urban salaries by 2015 is attained, according to a guideline issued by the State Council in February 2013, to deal with the country’s broadening wealth gap. As a result, China’s manufacturing-cost advantage over the U.S. has fallen to less than 5%.

Not only this, but manufacturing costs in eastern European nations – also offshoring havens – are at now equivalent to or above the level in the U.S. Apart from the U.S., the U.K. and the Netherlands in Western Europe and Mexico in Latin America can now be picked as low cost manufacturers.

Manufacturing “Renaissance” in the U.S.

Wages aside, there are also other factors that positively influence manufacturing or industrial activity in the U.S. Relatively low energy prices when compared to many of its global competitors are also playing a vital role in this boom.

The U.S. economy has now come a long way from the meltdown that occurred five years back. All economic indicators are improving from the pre-crisis level hinting at rising domestic demand for industrial equipment.

The European revival has also contributed to industrial growth in the U.S. As per Richard Bernstein Advisors (RBA), growing availability of bank financing for manufacturers is also driving the sector. All these factors should facilitate U.S. industrial and manufacturing companies to gain market share.

While there are several other factors to consider before shifting the manufacturing base from one nation, a company should also consider the proximity of target customers from the manufacturing base, as per BCG. But wage and currency are significant factors, and are lately providing all the needed support to the U.S. industrial sector  (read: Play Surging U.S. Manufacturing with These Industrial ETFs).

Funds discussed below offer targeted bets on the sector and can help investors garner profits if the wage differential continues to narrow down and if the U.S. continues to become a manufacturing powerhouse once more:

Industrials/Producer Durables AlphaDEX Fund (NYSEARCA:FXR)

This fund follows the StrataQuant Industrials Index which is based on the AlphaDEX stock picking methodology. Instead of focusing solely on the market cap, this technique closely monitors the stocks’ price appreciation/momentum, sales and earnings growth as well as value factors and ranks (see all industrial ETFs here).

The ETF has managed assets worth $809.9 million. In total, the product holds 102 securities, which are not at all concentrated on its top 10 holdings.

In fact, not a single company accounts for more than 1.79% of the basket. The strategy eases out the risk quotient of the fund. Investors have to pay 70 bps in fees and expenses which is higher than the average expenses charged by the industrial equities ETF.

FXR has gained 3.78% so far this year. The product has a Zacks ETF Rank of 1 or ‘Strong Buy’ rating with a ‘Medium’ risk outlook.

Vanguard Industrials ETF (NYSEARCA:VIS)

VIS tracks the MSCI US Investable Market Industrials 25/50 Index and invests about $1.65 billion in 340 holdings. The fund has moderate company specific concentrator risks with about 40% exposure in top 10 assets.

The fund gained about 0.52% so far this year. It charges a dirt cheap expense ratio of 14 bps a year. The fund has a Zacks ETF rank of 2 or Buy rating with a medium risk outlook.

Guggenheim S&P 500 Equal Weight Industrials ETF (NYSEARCA:RGI)

Yet another tempting, but often overlooked, option is RGI. The fund seeks to track the performance of the S&P 500 Equal Weight Index Industrials. So far, the fund has amassed an asset base of $91.7 million and is invested in 65 holdings.

In terms of performance, RGI is up about 1.43% year to date. Moreover, RGI charges about 40 basis points a year. Being an equal-weight product, RGI has a medium risk outlook while it carries a Zacks ETF Rank #2 as well (read:Overweight These Equal Weight ETFs in Your Portfolio).

Bottom Line

Although on a nominal basis daily wages in the emerging markets are still lower than that in the U.S., the wage growth has been higher in emerging nations than the developed ones with no sign of a change in this fashion, at least for the near term.

So, investors looking for industrial exposure should consider these products in their portfolio to book profits out of the ‘reshoring’ trend. These ETFs are the top-rated ones that have beaten similar products thus far and could run higher in the course of 2014.

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