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How to Build a Winning ETF Portfolio for Second-Half 2017

The first half of 2017 was great for the financial world thanks to a pickup in economic activity in many parts of the world, solid corporate earnings, rebound in commodity prices and support from central banks across the globe. This is especially true as the MSCI All-Country World Index logged in the best first half in 19 years. Moreover, the Dow Jones and S&P 500 notched their best first-half performance since 2013.

Will this bullish trend continue heading into the second half? This million-dollar question in the minds of many investors given looming concerns over Trump’s administration, Brexit uncertainty, geopolitical tensions, decline in oil price and lofty valuations. Additionally, emerging markets are expected to feel the pinch from policy tightening being adopted by the central banks around the globe, in line with the Fed policy (read: 6 ETFs to Buy if Global Tensions Flare Up).

However, if we go by history, stocks have generated positive returns in the second half of the year over the past two decades. The S&P 500 was higher 65% of the time with average gains of 2.7% according to CNBC's analytics partner Kensho while it gained 4.2% in the second half of the last 70 years per CFRA. The technology sector led the way 75% time over the past two decades, gaining 4.5%. Consumer staples and healthcare were the next two outperforming sectors in the second half while materials, utilities and energy were the biggest laggards.

Further, 64% of the Wall Street strategists expect the S&P 500 to gain another 5% in the second half per the CNBC survey. Almost 60% of the strategists expect financials to be the top-performing sector while 50% see technology as an outperformer in the next six months as well. Strategists are also optimistic about energy, health care and industrials.

Given the heightened uncertainty but historical outperformance of the stocks, investors should have some strategies in place for the second half that could safeguard them from downside while simultaneously offer capital appreciation opportunity. Here are some strategies that could prove extremely beneficial for investors in the months ahead:

Make Hot Sectors Your Friend

Technology and healthcare were the top two performing sectors of the first half and would remain investors’ darling in the second half when it comes to defensive trading. The financial sector regained its momentum especially after the third rate hike in six months and the stress test results. Additionally, the trio has an edge over the other sectors given the encouraging industry fundamentals. As the Fed’s gradual policy tightening and reduction of its $4.5 trillion balance sheet will remain on course, technology and financials will be favored by rising rate environment (read: Top Sector ETFs of 1H).

While the three sectors are crowded with a number of top ranked ETFs, the most popular are State Street funds – Select Sector SPDR Technology ETF XLK, Health Care Select Sector SPDR Fund XLV and Financial Select Sector SPDR Fund XLF – and Vanguard funds – Vanguard Information Technology ETF VGT, Vanguard Health Care ETF VHT and Vanguard Financials ETF VFH.

Emphasis on Investment Styles

Investors should seek some smart stock-selection techniques and strategies to bypass risks in the market. While there are several ways to do the same, investing in smart beta and guru ETFs could be the best way out. The smart beta strategy helps to capture market inefficiencies in a transparent way by adding extra metrics like dividends, volatility, revenue, earnings, momentum, equal weight and other fundamental factors to the market cap or rules-based indices. On the other hand, guru ETFs replicate investing styles and predictions of market experts like Warren Buffett, Bill Ackman, Daniel Loeb, Cark Icahn and David Einhorn, providing a solid and well-diversified portfolio (read: Beat the Market with These Guru ETFs).

Some of the funds in these spaces, namely First Trust Dorsey Wright Focus 5 ETF FV, iShares Edge MSCI USA Quality Factor ETF QUAL, PowerShares FTSE RAFI US 1000 Portfolio PRF, Global X Guru Index ETF GURU, AlphaClone Alternative Alpha ETF ALFA and Direxion iBillionaire Index ETF IBLN are worth a look. PRF has a Zacks ETF Rank of 3 or ‘Hold’ rating.

Focus on International Developed Market

International investing was encouraging in the first half and is likely to remain so. The Trump upheaval and rounds of weak U.S. economic data will continue to push investors to foreign stocks. In fact, the International Monetary Fund recently cut the growth forecast for the U.S. to 2.1% from the previous estimate of 2.3% for this year, citing uncertainty surrounding Trump reforms. Further, the global central banks have joined the Fed on the road to monetary tightening that would push international currencies higher against the U.S. dollar, making international investing tempting (read: International ETFs Top First-Half Asset Flows).

Among the most interesting picks, broad developed market ETFs like iShares MSCI EAFE Index EFA, Vanguard FTSE Developed Markets ETF VEA and Schwab Fundamental International Large Company Index ETF FNDF, and European ETFs such as FTSE Europe ETF VGK and iShares MSCI Eurozone ETF EZU could make for compelling choices. All these have a Zacks ETF Rank of 1 or ‘Strong Buy’ rating.

Bet on U.S. Small Caps

After lagging in the first five months of 2017, small cap stocks have regained their sheen and outperformed the broader U.S. market in June. The trend is likely to continue given geopolitics, Brexit uncertainty, the prospect of an end to the cheap monetary policy era across the globe and tension in the Gulf States. On the other hand, the U.S. economy has been on a firmer footing with the Fed rate hike, an impressive labor market, rise in wages and increase in consumer spending (read: Small Caps Outperform in June: 4 Best ETFs & Stocks).

Against such a backdrop, small cap stocks are the biggest beneficiaries as these are closely tied to the U.S. economy and do not have much exposure to the international market. These pint-sized stocks generate most of their revenues from the domestic market and are free from the clutches of any political malaise or a strong greenback. However, small cap stocks are highly volatile and could see huge losses in the crumbling stock market. As such, risk-tolerant investors with patience for extreme volatility should consider this space. For them, a couple of top-ranked ETFs – Vanguard Russell 2000 Growth ETF VTWG and PowerShares Russell 2000 Pure Growth ETF PXSG – could be excellent picks to tap the improving U.S. economy.  

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SPDR-TECH SELS (XLK): ETF Research Reports
 
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VANGD-FTSE EUR (VGK): ETF Research Reports
 
GLBL-X GURU IDX (GURU): ETF Research Reports
 
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VANGD-FTSE DV M (VEA): ETF Research Reports
 
Ford Motor Company (F): Free Stock Analysis Report
 
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