Next month, I will be speaking about portfolio construction with ETFs at a conference in Phoenix, and that got me thinking about industrials, which I think might be the most interesting sector when the next bull-market cycle begins.

Based on trading volume, the Industrial Sector SPDR ( XLI) would seem to be the most popular way to go, but XLI allocates 16% to General Electric ( GE), which has been on a brutal run of lagging the market and the sector.

Making GE's lag all the more troubling: Traditionally, the latter part of a cycle is when megacaps such as itself should have the best returns relative to other parts of the market. When new bull markets start, money usually flows into smaller cap stocks, which creates a big-picture headwind for GE.

A smaller-picture headwind could be greater awareness of some of the narrower industrial-sector themes drawing money into specialized stocks and away from companies like GE and other very large caps that dominate XLI.

The first step in building a sector allocation is deciding whether to be equal, overweight or underweight the sector versus the S&P 500. Currently, the industrial sector is 12.16% of the S&P 500.

I would want to be overweight the sector when the next bull does start. I will target a 16% weight for the sector, an overweight but not ruinous bet in case I turn out to be wrong.

Infrastructure is obviously a very important theme, and the iShares S&P Global Infrastructure Index Fund ( IGF) is the best ETF proxy for the industrial portion, as opposed to the utilities sector aspect, of the infrastructure theme. IGF is 33% industrials -- and while it is 38% utilities, the fund has tracked closer to the industrial sector. The fund allocates around 10% each to subsectors such as toll roads, airports and pipelines with slightly less to shipping related stocks.

Wind energy is another potentially important theme and industrials are the largest sector in both PowerShares Global Wind Energy Portfolio ( PWND) and the First Trust ISE Global Wind Energy Index Fund ( FAN).

The funds are heavy in turbine makers like Vestas Wind ( VWDRY) and Gamesa ( GCTAF). Wind could possibly be a more attractive investment than solar, because wind farm building is done at the corporate level, as opposed to trying to sell solar panels to individuals as well as companies.

Water is another big theme within this sector. The PowerShares Water Resources Portfolio ( PHO) allocates 74% to industrials. There isn't enough potable water in the world, and a lot of time and resources are being spent to rectify that.

One last important aspect of the industrial sector is the defense sector. In addition to a lot of money being spent on defense, as cold as it may seem, during certain kinds of stock market panics defense stocks go up. There are two very similar ETFs in this space; iShares DJ US Aerospace and Defense Index Fund ( ITA) and the PowerShares Aerospace and Defense Portfolio ( PPA).

In assembling this group to complete the 16% allocation outlined above, I would allocate 5% each into IGF and ITA. Both are larger cap and could serve as the core portion of the sector weighting. Then, allocate 3% each to FAN and PHO, which tend to be smaller cap.

I would expect the overall mix to be more volatile than owning XLI, but remember, the focus is on the start of the next bull market. If ever there is a time to increase volatility, it's at the start of a bull market. The mix provides exposure to most of the important themes going into the next decade without taking single stock risk.

Lastly, I would define a new bull market to have started when the S&P 500 goes back above its 200-day moving average -- and proves it can stay there.
At the time of publication, Nusbaum was long IGF and PHO personally and/or on behalf of clients, although positions may change at any time.

Roger Nusbaum is a portfolio manager with Your Source Financial of Phoenix, and the author of Random Roger's Big Picture Blog. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Nusbaum appreciates your feedback; click here to send him an email.

If you liked this article you might like

Woof! New ETF Applies Dogs of Dow Theory to Emerging Markets

Woof! New ETF Applies Dogs of Dow Theory to Emerging Markets

New ETF Lets You Collect Highway Tolls

New ETF Lets You Collect Highway Tolls

New Guru ETFs Go Global

New Guru ETFs Go Global

New First Trust ETF Combines Two Successful Methodologies

New First Trust ETF Combines Two Successful Methodologies

Is There Room for a Third China A Share ETF?

Is There Room for a Third China A Share ETF?