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By Jason Stipp | 08-26-2010 06:03 PM

Three ETF Ideas for Today's Market

Get Scott Burns' ETF ideas for yield-seekers, plus his take on the week's housing and M&A news.

Jason Stipp: I'm Jason Stipp from Morningstar and welcome to The Friday Five. This is our look back at five notable headlines of the week. Sitting in this week for Morningstar markets editor [Jeremy Glaser] is Scott Burns. He is Morningstar's director of ETF, closed-end, and alternatives research. Thanks for joining me, Scott.

Scott Burns: Thanks for having me.

Stipp: So, some interesting things this week. There wasn't a whole lot of good news, but I think at one place that we want to start off is the housing market, there were a couple of days of housing data, it looks kind of grim. What's your take on the numbers?

Burns: Yeah, I think--my initial take was, is there an echo in here? I mean, haven't we heard this before? I think we've heard this before. The housing numbers are coming in. The starts dropped to a level that was pretty much near the bottom that we saw on September '07 for housing starts.

So, it looks like the stimulus that was pumped in there – while it had some positive effects, it looks it's got a bit of a hangover there. So, I think – I'm calling it the housing market hangover here; so, not good news on the housing front.

Stipp: Would you say that we're going to need to have some more "medication," so to speak, to help the housing market get back on its feet?

Burns: I think we just have to take the pain. Unfortunately, we had an overinflated housing market from the debt. I think that the stimulus prevented a true settling. I mean, mortgage rates can't get any lower, and we just have to get to a point where folks have saved enough in this new environment where you can't just put zero percent down and get a house.

Two things have to happen; people have to save that 20% or whatever it is, for the first time homebuyers or housing prices have to come down, and they'll meet somewhere in the middle there. So, time cures all ills.

Stipp: Just takes that time.

Burns: Just takes that time.

Stipp: So, another piece of news this week on durable goods--it was much less than the market expected. I think it speaks to an overall problem with consumers and their sentiment and their overall feeling that they can make some expenditures on some bigger ticket items. Where are you seeing sentiment right now, and how long do you think we're going to be in this funk?

Burns: I think it's easy anecdotally, if you just kind of look around and talk to your neighbors, friends and co-workers and things like that. I mean, there is still a lot of fear right now in the market, and people are loath to do big ticket items, and you know a lot of what we're seeing is real necessity, and I think people are pushing off car purchases and – you know they are buying electronics, but they are buying small electronics. Things like appliances and stuff like that, people are not in a good place right now in terms of their confidence, and that's starting to reflect. So, even if the consumer confidence indicator looks like it's going up, I mean the proof isn't showing up in the actual spending.

Stipp: One group of people out in the market that does seem to have a little bit more confidence to spend is corporations, and we've seen the M&A activity heat up recently. Is this a bright sign? Is this something that, you know, maybe shows that there is some activity going on out there and it could be a good thing for the market and maybe some positive signs for the economy as well?

Burns: Right. So, investors can be selling out of things all they want, but ultimately a corporation if they have the means, or another corporation has the means, can buy that company out and that starts to set a floor as to what the actual valuation should be in that sector and in that area. So it's good to see M&A activity happening.

You have in the tech space right now, you have the hostile bidding war or competitive bidding war going on with Dell, HP, and 3PAR. You have the hostile $40 billion cash bid that BHP made for Potash, a company that was a real highflier before the downturn and now is actually with this M&A activity kind of retesting some of those highs in its stock price again.

I think what's interesting is that both those deals are all cash. The companies are looking at prices where they don't feel the need to have to go to debt or the equity markets to get money. I mean that starts to tell you that there is some real value shopping to go on there. 

The problem with M&A activity is it's not actually additive to the economy. So while it is additive to the stock market, it doesn't necessarily drive economic numbers better.

Stipp: One thing I'd like to turn and speak to you a little bit about--you are focused on exchange traded funds and some of the alternative investments out there. And as we've been watching very closely recently the fund flows, and I think ETFs have held up pretty well, while some other types of investments have seen flows out. A lot of equity mutual funds have seen flows go out of them. And I think some folks have said this is because there is a trend toward investors wanting passive investments recently. What do you think this trend means? Is active management really on the decline here, and are we going to just really start to see passive investments take the forefront?

Burns: Over the past 10 years passive investing has gone from around 10% of total assets to now approaching 30%. So a third of all the money out there. Whether it's ETFs or index mutual funds or other index products is passively invested.

You know what I think you ultimately get in a world where there is a lot of passive investing is very barbelled return. So when you buy active management you will either win big or lose big. And, over time, the losers will kind of drop out. The winners will start to build up rallies and people will naturally let greed overtake fear. And say, why am I getting the S&P 500 return when this manager over here is putting back-to-back 100% return years; that's where I want my money to be in. We'll start to see that pendulum swing again.

Stipp: Well, speaking of investment ideas, I have to get you on the hook for a couple of ETF investing ideas. We've heard a little bit about some of your take on the economy and some of the different sectors and how they are holding up. If you are going to put some money to work in ETFs right now what things would be on your radar?

Burns: Well, we are focused on yield, which is really hard thing to do right now in a kind of yield free world. We really like AMJ--that's the JPMorgan Alerian MLP ETF. That's currently yielding 5.3%. It's not quite the bargain it was six months ago. So this isn't necessarily backup the truck, but if you are looking to boost your yield, it's definitely something worth looking at.

We also really like global telecom right now--very steady business. I mean people will stop paying their heating bill before they'll stop paying their cable or phone bill. IXP, particular that's the iShares Global Telecom, that's yielding 4.4% right now. So that's a fund that it doesn't have a lot of growth prospects. But if you can earn 4.4% versus 2.5% with actually fairly similar risk characteristics, I mean that's where you want to put your money.

And then something for those that are a little more aggressive: Obviously, M&A is picking up in the tech sector right now, and what we like is XLKS so that's the small-cap version of the S&P, so it's the S&P 600, I believe, small-cap technology sector. So as the HPs and the Dells keep looking to gobble up the 3PARs of the world, those companies should see a lot of activity and really get a nice tailwind from that.

Stipp: Scott, thanks for the timely ideas and for joining me today on the Friday Five.

Burns: Thanks.

Stipp: From Morningstar, I am Jason Stipp. Thanks for watching.

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