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Dodge The Fiscal Cliff With Mega-Cap ETFs

Politicians from both sides of the aisle have started to sound a more optimistic tone regarding the chances of avoiding the fiscal cliff. Investors would do well to remember that what politicians say, and what comes to fruition, are often two different things. That and the fiscal cliff, the GDP-sapping scenario in which old tax reductions expire becoming new tax increases, will arrive in January unless a deal is hammered out before year-end.

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While there has been no shortage of ideas regarding which stocks and ETFs are to be avoided under the fiscal cliff, one market capitalization spectrum might help investors endure the worst-case scenario: Mega-caps.

There is no hard and fast definition on market value constitutes mega cap, but many analysts and investors believe it is anything north of $100 billion. Running to mega-caps has worked this year. As iShares Global Chief Investment Strategist Russ Koesterich notes, “during the first 10 months of the year, US mega caps gained 13% versus 11.5% for mid caps and 10% for small caps.”

The good news for investors looking to get involved with mega-cap ETF such as the iShares S&P 100 Index (NYSEARCA:OEF) is that, despite the outperformance, mega-caps are still cheaper than large, mid and small-caps, according to Koesterich.

“Currently mega caps are trading at 13x trailing earnings versus 14x for large caps, 18x for mid caps, and nearly 20x for small caps. In addition, mega cap companies remain the most profitable segment of the market, with a return on earnings of 23,” Koesterich wrote in a blog post.

OEF has gained almost 11 percent year-to-date compared to a gain of 10.2 percent for the SPDR S&P 500 (NYSEARCA:SPY). The ETF’s top-five holdings are Apple Inc. (NASDAQ:AAPL), Exxon Mobil Corporation (NYSE:XOM), General Electric Company (NYSE:GE), Microsoft Corporation (NASDAQ:MSFT) and Chevron Corporation (NYSE:CVX).

The more internationally-focused iShares S&P Global 100 Index (NYSEARCA:IOO) has returned 5.4 percent this year. About half of that fund’s country weight is ex-U.S. with the U.K., Switzerland and Germany combing for nearly 30 percent of the ETF’s weight. Exxon, General Electric, Microsoft, Chevron and International Business Machines Corp. (NYSE:IBM) are IOO’s top-five holdings.

“Given the environment, perhaps the most compelling reason to consider an overweight is that mega caps, along with large caps, have historically been more resilient to slowing domestic growth than small and mid cap companies,” wrote Koesterich.

Other mega-cap ETFs to consider include the First Trust Exchange-Traded AlphaDEX Fund (NYSEARCA:FMK). The median market capitalization of FMK’s holdings is $56.7 billion, but the fund looks cheaper on a valuation basis than OEF. OEF has a price-to-earnings ratio of 18.09 and a price-to-book ratio of 4.01. FMK’s P/E is 12.86 and its price-to-book ratio is 1.69, according to First Trust data.

FMK is highly allocated to discretionary names as Ford Motor Company (NYSE:F), Comcast Corporation (NASDAQ:CMCSA) and The Home Depot, Inc. (NYSE:HD) are the fund’s top-three holdings. Overall, the discretionary sector accounts for almost a quarter of FMK’s weight.

The Rydex Russell Top 50 (NYSEARCA:XLG) should note be overlooked, either. XLG tracks the Russell Top 50 Index and has gained 10.9 percent this year, meaning of the ETFs highlighted here, XLG is the second-best performer behind only OEF.

This article was originally written by The ETF Professor, and posted on Benzinga.

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