ETFs are designed to decrease risks by offering investors access to a group of stocks. However, the use of highly specialized indexes by ETFs can increase exposure to the riskiest sectors and lead to large losses when trends reverse. To find the right balance, we look for ETFs that have diversified holdings and can benefit from several investment trends.
Heading into 2014, we see several important economic themes developing that should have a large impact on stocks. In the U.S., robust retail spending in November and an upward revision to October's data has led to hopes that consumer spending will pick up in 2014. Since consumer spending accounts for about two-thirds of GDP, it is unlikely we'll experience a recession if this trend continues.
Recent data also indicates that Europe will finally be joining the U.S. economy in an expansion. And with Asian economies expected to expand too, this could be the first synchronized global expansion since at least 2008, when the credit market crisis sparked deep economic declines around the world.
Automakers could be among the biggest winners from a strong global economy. In the U.S., some analysts expect car sales to reach 16.4 million in 2014, the highest level since 2007. And with the average age of vehicles on the road now at 11.4 years, many consumers will want to replace their aging vehicles.
In Europe, analysts expect sales to increase for the first time in seven years, projecting 2.5% growth to 13.9 million vehicles. Demand from China is expected to be especially strong, with new vehicle sales projected to increase 4.8% in 2014.
Rather than trying to determine which car maker will be the biggest winner in this environment, we recommend First Trust NASDAQ Global Auto Index (NYSE: CARZ). This ETF holds all of the world's largest publicly traded car companies and is diversified with holdings around the world.
Average daily trading volume is low for CARZ at about 25,000 shares. However, when you place a trade for an ETF, the liquidity is largely determined by the holdings of the fund, and the top holdings of CARZ are all liquid stocks. A limit order should be considered to lessen trading costs, and there should be sufficient liquidity to fill most limit orders that are placed near the current bid or ask prices.
Assets in CARZ total $55.9 million. Generally, fund sponsors will keep funds open as long as they hold at least $50 million in assets. There is always a risk any ETF can be closed by its sponsor, and if a fund you own is shut down, it is usually best to sell the fund shortly after the announcement is made instead of waiting for the fund to redeem your shares.
Auto manufacturers are expected to grow earnings at a faster-than-average pace over the next five years. General Motors (NYSE: GM), for example, is expected to report average growth of 16.8% a year. Toyota Motor (NYSE: TM) is expected to post average growth of 33.2% a year, and Honda Motor (NYSE: HMC) should grow earnings at an average of 28.4% a year.
Based on the better-than-average growth rates, we believe that car makers should trade with a price-to-earnings (P/E) ratio that is at least in line with the average for the market. SPDR S&P 500 (NYSE: SPY) is trading with a P/E ratio of 17, while the holdings of CARZ have an average P/E ratio of 11.
Car makers are ending 2013 significantly undervalued and could gain more than 30% in 2014 as they catch up to the market.
Action to Take -->
-- Buy CARZ up to $40
-- Set stop-loss at $37.50
-- Set initial price target at $52.65 for a potential 32% gain in 2014
This article originally appeared on ProfitableTrading.com:
This ETF Could Be the Biggest Winner in 2014