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Is the Economy Improving? These 3 ETF Indicators Challenge

The evidence is hardly overwhelming at this stage. What's more, generalized correction fears can stimulate profit-taking on the biggest winners first. There is another way of looking at the possible development, though. Small cap stocks often underperform large caps when investors believe the domestic economy is in danger of weakening. In other words, a falling IWC:IVV price ratio is worthy of monitoring.

2. Hottest ETFs Under Heavier Selling Pressure. Year-over-year, five-star-rated Guggenheim Spin-Off (CSD) amassed 34%. Similarly, alternative energy via PowerShares WilderHill Clean Energy (PBW) claimed 42%, while PowerShares Dynamic Media (PBS) with super stand-outs like Google (GOOG), Disney (DIS) and DirectTV(DTV) vaulted a staggering 45% over the same period.

Unfortunately, these ultra-hot ETFs have been losing ground at a faster pace than the market at large. While none of these assets have tested the long-term 200-day moving average the way that the Dow Industrials had recently, the heavy volume of liquidation on growth assets bears watching.

3. Mid-Cycle Phase or Late-Cycle Phase of the Business Cycle.  Most analysts would likely describe the current economic environment as one with a moderate rate of growth, strong corporate profitability and an accommodative/neutral monetary policy backdrop. The description best fits the notion that the U.S. is in the middle of its economic expansion. Along these lines, investors that employ the business cycle to overweight and underweight assets accordingly often favor the energy and industrial sectors in the mid-cycle phase; they typically underweight utilities and materials here.

Yet, a funny thing happened on the way to the allocation party. Over the last month, the best performing sectors have been utilities and health care, as SPDR Select Sector Utilities (XLU) and SPDR Select Sector Health Care (XLV) have produced 2.5% and -0.4% respectively. The outperformance by these segments is more typical of a late-cycle phase.

Similarly, industrials and energy were some of the month-over-month underperformers with SPDR Sector Select Industrials (XLI) and SPDR Select Sector Energy (XLE) logging -4.0% and -5.2% respectively. Again, the sector percentages seem to point more to a late-cycle phase of a business cycle rather than a mid-cycle phase of an economic recovery.

I am hardly predicting a recession here. I am simply noting that investors, myself included, have shifted to more defensive areas that are more common during a slowing down of the economy. With the Federal Reserve presumably committed to winding down its quantitative easing (QE 3) experiment, as well as elevated measure of volatility in equity trading, a defensive posture certainly seems warranted.

What would change my mind? Should the Fed suspend an increment of tapering or even decide to inject more liquidity, expect asset prices to inflate once more and investors attempt to take advantage.

Must Read: Foreign Developed ETFs vs. Domestic Stock ETFs

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

Certified Financial Planner Gary A. Gordon, MS, is the president of Pacific Park Financial, an SEC-registered investment adviser in California. He has more than 23 years of experience as a personal coach in money matters, including risk assessment, small-business development and portfolio management, and has taught finance in Mexico, Singapore, Hong Kong, Taiwan and the U.S. He wrote the draft copy for Maverick Investing, a McGraw-Hill publication, and writes commentary for Seeking Alpha in addition to ETF Expert, for which he also hosts the ETF Expert Radio Podcast.
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