Three ETFs For the Third Quarter

by on June 30, 2009 | ETFs Mentioned:

With a rocky six months behind us, we turn towards the second half of 2009, a period long since filled with predictions over returns to growth and the end of a global recession. In many regards, the next two quarters will be a “make-it-or-break-it” session for the U.S. economy. If encouraging signs continue to appear, the recovery may gain momentum, and we could see ourselves headed back towards some semblance of the “good old days.” But, on the other hand, if the economy sputters and the stimulus plans implemented in the first half prove to be ineffective, we could see ourselves plunge deeper into the recession that has already claimed millions of jobs and erased billions of dollars of retirement savings. As we venture forward, here are three ETFs I think could post some attractive returns in the second half of the year.

iShares FTSE NAREIT Industrial/Office Capped Index Fund (FIO)

This ETF is designed to track the industrial and office sectors of the real estate market. While residential real estate statistics often grab the most headlines and may be of the most significance to many Americans, commercial and industrial real estate comprise the majority of the holdings of most publicly-traded REITs. Commercial real estate prices are often uncorrelated with home prices, depending instead on employment activity and demand for office space.

During the current recession, more than 6 million jobs have been lost, pushing the unemployment rate to 9.1% in May. Even the most optimistic economists anticipate that it is only a matter of time before this measure breaks into the double digits. The full effect of this pinch has likely not been fully felt by the commercial real estate market, since many lease contracts last for a year or more. Many believe that the commercial real estate market will continue the freefall begun by the residential sector some two years ago. So how could I possibly be bullish on FIO? There’s a few reasons.

I firmly believe that commercial real estate will be the next shoe to drop. But I don’t think the thud is going to be as loud as the market fears it will be. According to property research firm Reis Inc., the office vacancy rate will rise to 16.7% in 2009, and could reach 17.6% in 2010. Many analysts see vacancy rates topping 20%. These would not only be a significant increase from the first quarter of 2009, but would exceed the vacancy rates following the 2001 stock market bubble and come close to those seen in the early 1990s in the wake of the S&L crisis.

I’m sure that many REITs will see their vacancy rates skyrocket and face declining lease revenues. But I think that we are also seeing signs that unemployment will soon peak, and may reverse course shortly thereafter. Moreover, a number of REITs have the capacity to take on additional debt and banks may finally be willing to lend, presenting the possibility of opportunistic buying for those firms that are on solid ground and enhanced liquidity for those that do struggle in the second half. Because of these factors, a wave of bankruptcies and foreclosures is an extremely unlikely scenario.

PowerShares DB U.S. Dollar Bullish Fund (UUP)

If you could stomach my first contrarian fund, hopefully you can handle a second. UUP is designed to track the performance of the U.S. dollar against six major world currencies. The cases for a weak dollar are numerous. The U.S. government has been saddled with a record amount of debt. In trying to spend our way out of this recession, we’ve been printing money like drunken sailors, causing some to speculate that runaway inflation will be the next “black swan” to devastate the global economy. China and Russia, among others, have called for an overhaul of the currency reserve system, replacing the dollar with a synthetic currency administered by the IMF. And the list goes on.

So why the optimism on the strength of the greenback? Again, I think that a number of “worst case scenarios” have been built into prices, with fears of unlikely scenarios driving the dollar down against its major rivals in the first half of the year. For all the doom-and-gloom predictions about double digit inflation, we remain in an environment where deflation is more of a concern. China recently announced that it won’t be making any sudden changes to its “stable” monetary policy, confirming what many already knew – that dethroning the dollar as the world’s central currency won’t happen overnight and faces many significant obstacles. Almosst every nation in the world continues to stock its foreign reserves with U.S. dollars, despite increasing momentum for a change to the system.

While I’m convinced many of these fears are overblown, that’s not the only reason I think UUP might be going up in the third quarter. U.S. interest rates can’t go any lower, and any increases would ccertainly give the dollar a shot in the arm. The equities market have managed to sustain an extended rally. If we do see good news continue to emerge this quarter and fuel the Wall Street rally, demand for the dollar would increase further.

PowerShares Dynamic Pharmaceutical Portfolio (PJP)

While it has disappeared once again from the front page headlines in the U.S., swine flu is still very much a global threat. Public anxiety has subsided in the U.S., but reminders of global fears remain, as evidenced by the sight of election officials donning surgical masks during this weekend’s elections in Argentina. While it has faded to the background for the time being, the pharmaceutical industry continues to work to develop and distribute vaccines in the event the disease (and widespread panic) return later in the year as flu season nears.

Swine flu doesn’t have to be a devastating pandemic to make waves on Wall Street. As long as it remains a possible threat, fear will dominate, prompting the need to develop and test vaccines. All of this, of course, could give a big boost to big pharmas who develop and market such drugs. It has been reported that two frontrunners have emerged in the race to find a vaccine: Sinovac Biotechnology and Baxter International.

Apart from swine flu, pharma ETFs should be in focus in the third quarter as the Obama administration continues its push for broad-based healthcare reform. While little progress has been made to this point (the administration has, after all, had its hands full with the economic mess), details on proposed plans from both sides should begin to emerge over the summer months. And although it’s too early to tell who the winners and losers of such reform would be, it seems logical that big pharmas could benefit tremendously from a massive increase in the number of insured presecirtion drug users.

Disclosure: No positions at time of writing.