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(Cinda Chavich)
(Cinda Chavich)

TheStreet.com

ETFs for a recovering economy Add to ...

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.

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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 per cent 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 per cent, 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 per cent.

Other positive statistics include a 2.8 per cent 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 per cent in the first quarter.

On Monday, the world's largest construction equipment maker, Caterpillar 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 . 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 , which witnessed a 43 per cent 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 per cent.

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 , which gives exposure to package carriers like United Parcel Service(UPS), freight carriers like Union Pacific and airlines like Continental Airlines . 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 , which lists among its top holdings Caterpillar, United Technologies and General Electric . 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 , which holds construction services company Jacobs Engineering and building materials company Owens Corning 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. , which posted its first increase same-store sales in two years.

Elsewhere, high-tech bellwether Intel 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 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.

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