Earnings Estimates Favor Industrial, Health ETFs

Exchange-traded funds that track various sectors of the S&P 500 have become such popular investments that it is important to regularly track their performance.

The chart at the bottom of this page shows the expected year-on-year changes in second-quarter earnings for each of nine SPDRs that together represent the spectrum of sectors in this index.

Estimates for second-quarter results indicate that that industrials, health care, and technology-related ETFs were the top-performing sectors for the period.

Industrial Select Sector SPDR XLI led the sectors in estimated earnings growth, which increased 13.5% compared with the second quarter of 2006. Companies in this ETF are benefiting from a trifecta of economic events: an apparent recovery in domestic manufacturing activity, robust export demand and a weak U.S. dollar.

The last two factors disproportionately benefit the firms represented in this ETF, which get 35% of their sales from abroad -- higher than any other sector except the tech sector's 36%. At 17.3 times this year's EPS, the Industrial Select ETF trades at a slight premium to the market's multiple of 16. F undamentally speaking, however, the wind does appear to be at the backs of industrial companies.

At the opposite end of the growth spectrum is Consumer Discretionary SPDR XLY, where forecast earnings were down about 7% -- the only sector to show a decline. Weakness is particularly evident in the homebuilders and auto-related companies in the sector.

Retailers, while always a diverse bunch, are expected to be about flat on the whole as good job and wage growth offsets the drag from housing. If that picture isn't bleak enough, consider this: The consumer discretionary fund currently trades at 20.6 times estimated EPS for this year -- only tech has a higher price-to-earnings ratio -- and estimates have been falling fast.

Meanwhile, the all-important Financial Select Sector SPDR XLF ETF is the second-largest estimated earner, even with only 3.6% earnings growth. Earnings have slowed for companies in this ETF as the positive effects of the merger-and-acquisitions boom were diminished by fallout from the subprime mortgage debacle.

Still, I believe the eventual growth number for this ETF could easily double current expectations if the upside surprises of recent quarters are repeated. The sector trades at just 12.3 times the estimated 2007 EPS.

In the Technology Select Sector SPDR XLK ETF, weakness in semiconductors is weighing on earnings, where estimated second-quarter growth is 7.2%. That's pretty slow for a sector trading at 21 times estimated 2007 EPS.

Were it just a temporary lull, it might be tolerable. But the lackluster growth in tech appears to be the norm in recent years. Since 2002, companies in this ETF have grown earnings at a compound annual rate of 15.1%, barely surpassing the 14.7% growth rate for the more stable S&P 500 as a whole.

Change in Second-Quarter Earnings by Sector (mil)

Source: ETFResearchCenter.com