Sweta Killa: The U.S. stock market has shown strong resilience over the past few months outplaying lofty valuation concerns and global turmoil following geopolitical tensions in Russia, Ukraine and Iraq, sluggish Euro zone recovery and stability in China. This is especially thanks to an accelerated job market, regained housing market momentum and stepped-up economic activities after the first-quarter slowdown.
Further, renewed tensions between Ukraine and Russia due to fresh sanctions by the West, and the crackdown of a Malaysian Airlines jetliner near the Russian/Ukrainian border appear to only be temporary setbacks. The stock market has already endured such threats a number of times this year (read: Russian Sanctions and Malaysian Plane Crash Put These ETFs in Focus).
Given bullish fundamentals and growing optimism, a New York-based research firm, Goldman Sachs (GS), lifted its expectation for equity returns. The S&P 500 index is expected to climb to 2,050 by the end of 2014 from the previous projection of 1,900. This represents a modest 3.6% gain from the close of the last trading session. Most of the gains will likely come from strong earnings, which is expected to grow 8% annually.
According to David Kostin at GS, the equity rally will be at the shallow pace. Though domestic economic growth is improving and earnings will continue to rise, the market expectation for the Fed hike within 12 months could limit the P/E multiple expansion. The S&P 500 index currently trades at 15.5 times the forward 12-month earnings, much higher than the 5-year and 10-year historical averages of 13.5 and 14.1 but below the loft days of the tech bubble in the late 90s.
Further, the U.S. equity market also appears attractively valued when compared to bond markets. This is especially true as the fixed income strategists at GS lowered the 10-year Treasury yield forecast by 25 bps to 3% on improving economy that could lead to interest rate hike in the third quarter of next year.
In fact, Kostin expects “lower valuation stocks and those with weak balance sheets, low returns on capital and low margins will lead the market’s gains before the Fed’s interest rate tightening’’. Investors seeking to ride on Goldman’s views could choose from a variety of products available in the ETF form.
While several ETF options could make a great play if Goldman Sachs’ prediction comes true, we have highlighted three funds that also have a favorable Zacks ETF Rank of 1, 2 or 3.
Vanguard Value ETF (NYSEARCA:VTV)
For a pure play on lower valuation, investors could focus on value ETFs like VTV. This fund seeks to track the CRSP US Large Cap Value Index, which measures the performance of a number of the largest U.S. value stocks. With AUM of $14.7 billion and an expense ratio of 9 bps, VTV is one of the largest and cheapest funds within the space (read: 3 Excellent Value ETFs Poised to Outperform).
The fund holds 311 stocks, which are pretty well spread across each component as none of these holds more than 4.2% share. Exxon Mobil (XOM), Microsoft (MSFT) and Johnson & Johnson (JNJ) occupy the top three positions in the basket. From a sector look, financials take the top spot with one-fifth share while health care, industrials and oil & gas round off to the next three spots with double-digit allocation.
The ETF sees solid trading volume of more than 726,000 shares, suggesting a slight extra cost in the form of tight bid/ask spread. The product added 8.6% in the year-to-date time period and has a Zacks Rank of 2 or ‘Buy’ rating with Medium risk outlook.