ETF Update: High Risk, But Some Opportunity

We examine markets with different time frames. Our most successful investor program takes a long view, but we also look to shorter term signals for trading programs. This week we see high risk in most sectors, but an opportunity for the careful trader to stay with the rally. This eclectic strategy has been very effective in recent months.

There is plenty of skepticism. That means that most missed last week's big move. A disciplined approach that looks for opportunity can help with this challenge.

Our Approach

We study sectors continually, looking at the charts and ratings for hundreds of ETF's. Each week we provide a list of our top-rated sectors for the next three weeks, along with some of our current observations. ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation. Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF system. (For new readers, there is a more complete description of our methods at the end of the article. We also have a free report with more detail on the system and results, available on request.)

The Macro View

From an overall market viewpoint, our indicators continue in positive territory, although it is a close call. The key elements are as follows:

• We now find 95% of our ETF's in positive territory (99% last week). The median strength rating for the overall list is 25. We are changing from mean to median strength in our weekly reports, because the median is a more helpful and robust measure. (A score of "0" implies the average long-term ETF expectancy.)
• 95% (up from 86%) of our sectors are in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons. You can think of this as a sophisticated "stop loss" rule, often applied in advance.
• Our index package remains slightly positive. For this rating we look at the ETF's (both long and short) for the S&P 500, the Dow, and the Nasdaq. You can see these ratings is the results table for this week.

Despite the many risky sectors, the model is finding some good trading choices.

A Look Back at Choosing an ETF

In our last update we highlighted weighting as a factor for traders in choosing an ETF. We noted that those with a longer time frame should be reading the prospectus and looking at many other considerations. We are delighted to note some wise advise on this front.

Patrick, one of our best commenters, cites tracking and expense ratio as big considerations. Well put.

David Merkel, one of our favorite and featured sources, also has an excellent article on ETF selection, citing many factors relevant to long-term investors. Check it out!

Also, Abnormal Returns notes that the size of the fund makes a big difference, impacting both the ability to trade and even the value of underlying assets.

Focus on Asia

This week's sector focus is the iShares MSCI Hong Kong Index Fund (EWH). The fund has a beta of about 1 and a P/E ratio of around 25. Most investors do not know much about selecting individual stocks on the Hong Kong market, so the ETF is a good way to play China growth and dollar weakness. The top ten holdings make up about 65% of the fund.

Here is the chart (click to enlarge).

The model has noted some basing and a possible breakout. It is a promising story (we bought at the close on Thursday) but it could change quickly.

Gary Gordon notes the key question: Will the Asian growth continue as many expect?

Weekly TCA-ETF Rankings

We had a gain of over four percent last week, roughly in line with the S&P 500. Our current holdings are not near the top in strength rank, but they still have good ratings. Our testing has shown what Vince calls "robust" results for anything with a positive strength rating. We do not buy ETF's in the penalty box or those with poor liquidity. We provide these ratings as information for readers who may not trade as frequently as we do. Those signing up for our free weekly email update can also get the entire list.

[We also note that two weeks ago we implemented what our modeling guru, Vince Castelli, calls an improved filter. While the underlying model has not changed, the inputs used reflect our best efforts to improve the signal-to-noise ratio. We have advanced the timing (the Anticipation factor) reflecting the recent "hot money" tendencies in ETF's. This means earlier recognition and also faster moves to the penalty box. Those tracking our entire data series should keep this in mind.]

As noted above, all of the macro market indicators remain positive, although most are in the penalty box. Based upon the current model signals, we have maintained (by a whisker) our bullish position in the Ticker Sense Blogger Sentiment poll.

Here are the top sectors from our expanded universe of 280 ETF's. The list also includes the values for the broad market ETF's and their inverses (click to enlarge).

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation. Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method. In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike. While we urge readers to check out the entire article, the key point is that ETF's pose challenges and opportunities different from investment in individual stocks. The fundamentals may be more difficult to assess. Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETF's. This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves. Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF. While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box." The basic elements are used by many, and widely reported. We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model. We monitor and trade this daily, and offer a free report (request via the email address on the top left of the site) for those interested in our weekly trading program.

Comments

[enigmaman:]

Jeff, seems like your trying to thread the eye of a needle as it relates to finding some additional green shoots in a garden full of weeds. You said "95% (up from 86%) of our sectors are in the "penalty box." This means that they are currently disqualified from the buy list for technical reasons." At this point in the game wouldn't it be wiser for most to just sit on the bench to see how the game plays out in the near term, at this level only the seasoned well disciplined investor should be sitting at the table.

Why not discuss some other strategies, a holding pattern, an exit strategy, some alternative plan, or how to react when there is a significant bump in the road, that would seem to be the prudent course at this stage of the game and very helpful, that is unless you believe we are just in the first few inning of a new ball game with plenty of upside. Im not saying think the worst just what if, pays to be ready just in case

Oct 12 08:30 AM

[Jeff Miller:]

Enigmaman --- Good question! I can say this honestly because it is one that I raised in discussing the output with Vince. His response was to go back and check some data. He says that we have "robust" results whenever we have a positive rating on a particular ETF. The penalty box exit is now more sensitive in an effort to avoid the "rush for the exits" mentality sometimes seen in this trading.

If we had followed this strategy last week, when things looked about the same, we would have missed a nice week.

Meanwhile, I am compiling data on how the penalty box and the index package have done as macro indicators.

Thanks for taking the time to make your thoughtful comment.

Jeff


On Oct 12 08:30 AM enigmaman wrote:

> Jeff, seems like your trying to thread the eye of a needle as it
> relates to finding some additional green shoots in a garden full
> of weeds. You said "95% (up from 86%) of our sectors are in the "penalty
> box." This means that they are currently disqualified from the buy
> list for technical reasons." At this point in the game wouldn't it
> be wiser for most to just sit on the bench to see how the game plays
> out in the near term, at this level only the seasoned well disciplined
> investor should be sitting at the table.
>
> Why not discuss some other strategies, a holding pattern, an exit
> strategy, some alternative plan, or how to react when there is a
> significant bump in the road, that would seem to be the prudent course
> at this stage of the game and very helpful, that is unless you believe
> we are just in the first few inning of a new ball game with plenty
> of upside. Im not saying think the worst just what if, pays to be
> ready just in case

Oct 12 08:09 PM