How to Find Hidden Gems in This Uncertain Market

This article was originally published by Zacks.com

With many stocks at record highs, it seems as though several corners of the market have run out of steam. After all, the Russell 2000 is more or less flat this year, while the DJIA has added less than 5% so far in 2014.

And with tensions high in the Middle East and Russia, international investing seems dicey too. But for those looking for solace in safer assets like bonds, the imminent end of Quantitative Easing (QE) could spell doom here in the near future.

Yet even with this backdrop, there are plenty of sectors and industries - or even other countries - that have been posting better numbers than these anemic returns to start 2014. As they say 'there is always a bull market somewhere' and that has proven to be the case this year too.

Big Winners in Today's Flat Market

If investors drill down into niche markets, a number of huge winners emerge. In fact, several often-overlooked corners of the investing world have added more than double digits so far in 2014.

For example, both the biotechnology and solar sectors have seen gains that have already exceeded 20%. Internationally, Indian markets took the world by storm, with many sectors in this economy adding more than 33%. But outperformers aren't limited to the equity world, as coffee futures have put up gains approaching 60% in 2014!

While it would have been great to be holding on to any of these big winners, it doesn't do much for your portfolio right now. Tomorrow's winners will likely be very different from what has worked well in the past, so the question remains: How do you find these hidden gems?

Where to Look for Diamonds in the Rough

Arguably the most important factor for determining returns is what sector you choose. Our research shows that securities in the top half of the Zacks Industry Rank list outperform those in the bottom half by a factor of 2 to 1.

By focusing your efforts on the top ranked industries, you are already ahead of most investors. And if you make sure to cycle out of sectors as their estimate revisions decline and others move up the charts, you can prevent your portfolio from being sucked into industries with unfavorable trends.

Right now, a couple of key industries are surging up the Zacks Industry Rank list, and I am targeting them in the near future for investment. These include both semiconductors and the aerospace & defense industry, as both of these sectors have Zacks Industry Ranks in the top 40%, suggesting they are likely to see solid trading ahead.

Best Way to Find These Hidden Winners

While individual stock selection is always an important part of a portfolio's strategy, the rise of the Exchange Traded Fund (ETF) world over the past decade has really 'democratized' the investing landscape, and allows for easy ways to make sector focused selections. Now, even the smallest retail investor can buy up shares in Brazilian stocks, hold commodities like coffee, or receive coupon payments from Asian debt securities.

But with nearly 1,700 ETFs on the market, how does an investor find the best ETF for his or her portfolio? The key to doing this is to focus on the Zacks Industry Rank, and to also consider the following two key ETF-specific investing points as well:

Zacks ETF Rank

Close to 700 ETFs are ranked with this proprietary system that was specifically built to find ETFs that can deliver outperformance. The process is built on the Zacks Rank and the Zacks Industry Rank, but it also takes into consideration a number of ETF specific factors as well, including expense ratios and bid ask spreads.

Investors should note that this methodology doesn't just focus on U.S. equity ETFs, as a number of other types also have ranks in this system, including currency, commodities, and foreign markets. Consider taking a closer look at the Zacks ETF Rank the next time you want to buy a fund, as this could help you to narrow down the list, or point you in the right direction in terms of which non-U.S. equity funds are poised for solid returns.

Proper ETF Selection

Even if you find the right trend in a market, picking the right ETF to play the idea is absolutely crucial. Funds now give investors the option to weight a given index by market cap, dividends, earnings, or even using an equal approach. Additionally, for many countries, investors now have the option to hedge out currency exposure, while cap level targets need to be considered as well.

While these might not seem like major differences, they can actually drastically impact overall returns. An equal weighted version of the S&P 500 has actually outperformed the traditional market cap weighted version by 800 basis points over the past two years, even though both held the exact same stocks!

And looking internationally, a hedged currency fund to play Japan would have netted you more than twice as much in profits than simply going with the most popular Japan fund in the space. Clearly, it is not enough to be correct in the sector or nation, investors must also find the right fund to play their outlook as well.

Where to Find the Best ETFs Now?

The above ingredients will get you on the right track to finding the best ETFs. However, many investors regard the Exchange Traded Fund world as a foreign land, and with close to 1,700 products in this market, there are a paralyzing number of choices at an investor's disposal even when narrowing them down with the key points outlined above.

Fortunately, we are now launching a portfolio service that distills all these hundreds of funds down to less than a dozen that are primed for outperformance over the next few months. Today, I encourage you to see if it is right for you and your investing strategy. Go ahead and take a look at our brand-new Zacks ETF Trader.

We are restricting the number of investors who share its trades, so access to this portfolio closes to new investors Saturday. But if you get in right now, you can still be first in line for the first 5 "hidden gem" ETFs that I am posting early next week. In fact, you can see them and also look inside all of the other Zacks portfolios for the total sum of only $1. Don't miss your chance for access that ends Saturday, September 13th just before midnight.

Eric Dutram is Zacks' authority on Exchange Traded Funds, which trade like stocks but let you ride trends without: (1) risk of buying one sinking company in an otherwise booming industry, and (2) paying extra fees by adding numerous stocks, one at a time. He directs our new portfolio, the Zacks ETF Trader.

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