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ETFs for a Recovering Economy

These ETFs track stock market sectors that should outperform as the economy recovers.

NEW YORK (

TheStreet

) -- Today we'll look at four exchange-traded funds (ETFs) that track stock market sectors that should benefit from the economic recovery.

The U.S. stock markets have witnessed their biggest rally since the Great Depression and remain relatively cheap. Meanwhile, data show the economy is on the mend. This should spell more gains for the ETFs that track the following stock markets sectors: transportation, manufacturing, construction and consumer discretionary.

In terms of an overall U.S. economic recovery, statistics have been favorable. According to the Department of Labor, initial jobless claims are dropping, and the total number of people collecting some form of unemployment benefits, whether from the federal government or from states, is dropping as well. In fact, initial jobless claims are down nearly 27% from a year ago, and the total number of individuals receiving unemployment benefits has declined to 10.54 million. In the month of March, nonfarm payrolls rose by 162,000 and private-sector payrolls jumped 123,000, indicating that companies are starting to hire.

A second favorable statistic comes from the real estate markets. In March, sales of new homes jumped 27%, the largest increase in 47 years. In February, the S&P/Case-Shiller home price index witnessed its first increase since December of 2006, climbing 1.3%.

Other positive statistics include a 2.8% increase in orders for nontransportation durable goods and stellar first-quarter corporate earnings. Income for companies in the

S&P 500

has been beating Wall Street's expectations by 22% in the first quarter.

On Monday, the world's largest construction equipment maker,

Caterpillar

(CAT)

beat analyst expectations and reported increases in profits. This outperformance was driven primarily by rebounding construction and mining activities in developing nations and is indicative of improving global economic conditions.

Another company that shattered Wall Street's expectations was the world's largest appliance maker,

Whirlpool

(WHR)

. The Benton Harbor, Mich.-based company reported first-quarter profits of $2.13 per share, easily surpassing analyst expectations of $1.33 per share. This is indicative of an uptick in consumer spending.

Another notable mention on the earnings front is transportation provider

Union Pacific

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, which witnessed a 43% increase in profits as it hauled more goods.

Overall, the health of the economy is improving, which is one reason that the International Monetary Fund revamped its forecast for 2010 U.S. GDP growth to 3.1%.

Despite stellar first-quarter earnings and a record pace of beating Wall Street's expectations, equities remain relatively cheap. The S&P 500 index, the benchmark gauge for American equities, is trading at a price-to-earnings ratio of nearly 14, one of its lowest P/Es during the past 20 years.

The following four sectors generally are the most sensitive to changes in the overall state of the economy and are likely to growth as the economy continues to recover:

Transportation: As the economy picks up, more goods are shipped, traveling increases and consumers are more inclined to purchase new vehicles. A good play on this cyclical sector is the

iShares Dow Jones Transportation Average

(IYT)

, which gives exposure to package carriers like

United Parcel Service

(UPS)

, freight carriers like Union Pacific and airlines like

Continental Airlines

(CAL)

. IYT closed at $85.79 on Monday.

Manufacturing: As economies grow, demand for durable goods generally follows. A good way to gain exposure to the manufacturing sector is through the

Industrial Select Sector SPDR

(XLI)

, which lists among its top holdings Caterpillar,

United Technologies

(UTX)

and

General Electric

(GE)

. XLI closed at $33.19 on Monday.

Construction: In general, when the economy booms, so does construction as companies tend to expand and consumers seek new housing. Additionally, the focus on infrastructure spending by governments further bolsters this sector's appeal. A notable mention here is the

PowerShares Dynamic Building & Construct

(PKB)

, which holds construction services company

Jacobs Engineering

(JEC)

and building materials company

Owens Corning

(OC)

in its top holdings and isn't solely focused on homebuilders. PKB closed at $13.98 on Monday.

Consumer Discretionary: As the economy recovers, so does consumer spending. In fact, this has already begun, which is one reason we're seeing the strong boost in corporate sales. For evidence, look at restaurant chain

Cheesecake Factory Inc.

(CAKE)

, which posted its first increase same-store sales in two years.

Elsewhere, high-tech bellwether

Intel

(INTC)

reported its best-ever first-quarter sales and operating income on strong consumer PC sales. A notable mention here is the

Consumer Discretionary Select Sector SPDR

(XLY)

. XLY closed at $35.95 on Monday.

Although these sectors are likely to show signs of growth, they are also the most susceptible to changes in the business cycles, which increases their risk.

A good way to protect against this risk is through the use of an exit strategy that identifies price points at which an upward trend could come to an end.

According to the latest data at

www.SmartStops.net

, these price points are: $81.93 for IYT; $32.07 for XLI; $13.01 for PKB; $34.63 for XLY. These price points change on a daily basis and are reflective of market volatility as well as macroeconomic and microeconomic factors. Updated data can be found at www.SmartStops.net.

-- Written by Kevin Grewal in Laguna Niguel, Calif.

At the time of publication, Grewal had no positions in stocks mentioned.

Kevin Grewal serves as the editorial director and research analyst at The ETF Institute, which is the only independent organization providing financial professionals with certification, education, and training pertaining to exchange-traded funds (ETFs). Additionally, he serves as the editorial director at SmartStops.net where he focuses on mitigating risks and implementing exit strategies to preserve equity. Prior to this, Grewal was an analyst at a small hedge fund where he constructed portfolios dealing with stock lending, exchange-traded funds, arbitrage mechanisms and alternative investments. He is an expert at dealing with ETFs and holds a bachelor's degree from the University of California along with a MBA from the California State University, Fullerton.