ETFs Poised for a Possible 'Pop'

In any significant market downturn, smart investors will be looking to get well-positioned to capture upward movements during the recovery.

It is subject to debate whether the market's recent progress is a sign that the worst is behind us. If it does turn out that we're entering a period of a strong market recovery, there are some areas in which it may be smart to have some money.

"Those that have been the most depressed" are the best areas in which to be invested, says Mark Luschini, chief investment strategist for Janney Montgomery Scott.

Two areas that Luschini believes have good upside potential if the market is to see a prolonged recovery are financials and consumer discretionary.

ETF investors looking to position themselves in these areas have several options. On the financials front, there are funds to consider such as the Financial Select Sector SPDR ( XLF), the Vanguard Financials ETF ( VFH) and the iShares Dow Jones U.S. Financial Sector ( IYF).

These funds each have dividend yields between 3% and 4% and have top holdings such as Bank of America ( BAC), JPMorgan Chase ( JPM) and American International Group ( AIG).

As for consumer-discretionary ETFs, investors could look to the Vanguard Consumer Discretionary ETF ( VCR), the PowerShares Consumer Discretionary Fund ( PEZ) or the Consumer Discretionary SPDR ( XLY).

These funds have top holdings such as McDonalds ( MCD), Nike ( NKE) and Walt Disney ( DIS).

Joe Battipaglia, market strategist at Stifel Nicolaus, agrees with Luschini on the upside potential for financials.

"If we were to come out of a recession, financials would obviously be a big performer because they have been so beaten up," he said. "I also think two other areas that would do well are REITs and high-yield bonds because of their spreads relative to Treasuries."

To get into high-yield bond ETFs, investors might find it worth their while to check out the SPDR Lehman High Yield Bond ETF ( JNK), the iShares iBoxx High Yield Corporate Bond Fund ( HYG) or the PowerShares High Yield Corporate Bond Fund ( PHB).

And for REIT ETFs there is the Vanguard REIT Index ETF ( VNQ) and the DJ Wilshire REIT ETF ( RWR), which both have dividend yields of approximately 5%.

Greg Dahlman, senior vice president and portfolio manager for Dana Investment Advisors, is focusing on sectors that have the potential to outperform their earnings estimates.

"The big story is where the estimates are going," he said. "If you underpromise and overdeliver, your stock is going to be rewarded. Being in sectors and stocks that don't revise downwards and don't surprise to the downside is key."

Although bullish conditions are generally welcomed by investors, there are always going to be sectors that will fall victim to underperformance. Avoiding these areas is vital to building a winning portfolio.

"You want to keep in mind not only where you are putting your money, but also where it is coming out of," Luschini says.

Health care, a sector that has been historically considered to be defensive in nature, is one area of the market that Luschini thinks could be susceptible to outflows of money if the market continues to gain steam.

Should this trend materialize, it could make for a rocky road for ETFs in the health-care space such as the Health Care Select SPDR ( XLV) and the Vanguard Health Care ETF ( VHT).

These funds have only recently begun to move off of their 52-week lows. They contain names such as Johnson & Johnson ( JNJ), Pfizer ( PFE) and UnitedHealth Group ( UNH).

And what if the U.S. dollar begins to rebound at some point?

Luschini points out that such a movement could prove to be problematic for portfolios that are heavily concentrated with international exposure.

"You would want to reconsider multinational corporation-themed ETFs and foreign-themed ETFs," he said.

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