Where is the most attractive current target for emphasis among sector ETFs?
This article will look at 30 different sector ETFs in ten sector categories to see what upside price goals are realistic at present, how often such goals were reached in the past, what size gains, net of losses, were achieved previously, and how bad a price drawdown scare had to be endured on the way to those prizes.
We will draw on the price range forecasts produced by Intelligent Behavioral Analysis of the way that market-making professionals hedge at-risk positions. Positions that they must take, helping their big-money-fund clients, as the clients use these ETFs to adjust their portfolios' make-ups. To evaluate how well those forecasts may be accomplished in the next few months, we will look to the past five years' experiences, at the times when specific ETF outlooks had the same upside-to-downside balance they have now.
Sector ETFs are provided by three principal issuers, Standard & Poors' SPDR offerings, Vanguard ETF creations, and iShares products from BlackRock, plus a few by others. They tend to duplicate one another in their focus and contained holdings, but for reasons not entirely clear, the market performances, while often similar, are usually not identical.
Here are the ETFs, grouped by their focus, with symbols and names:
DBE POWERSHARES DB ENERGY FUND
IYE DJ US ENERGY SECTOR iSHARES
VDE VANGUARD ENERGY ETF
XLE S&P ENERGY SECTOR SPIDER
[IYH DJ US HEALTHCARE SEC iSHARES
VHT VANGUARD HEALTH CARE ETF
XLV S&P HEALTH CARE SECTOR SPDR
IGV S&P NA TECH-SOFTWARE SECTOR
IYW DJ US TECHNOLOGY SECTOR INDEX
VGT VANGUARD INFORMATION TECHNOLOGY
XLK S&P TECHNOLOGY SECTOR SPIDER
XSD S&P SEMICONDUCTOR SPDR
IYF DJ US FINANCIAL SECTOR iSHARES
IYG DJ US FINANCIAL SERVICES iSHARES
VFH VANGUARD FINANCIALS ETF
XLF S&P FINANCIAL SECTOR SPIDER
FXD FIRST TRUST CONSUMER DISCRETIONARY ETF
VCR VANGUARD CONSUMER DISCRETIONARY ETF
XLY S&P CONSUMER DISCRETIONARY SECTOR SPDR
VDC VANGUARD CONSUMER STAPLES
XLP S&P CONSUMER STAPLES SECTOR SPIDER
XRT S&P RETAILING SPDR
IDU DJ US UTILITIES iSHARES
VPU VANGUARD PUBLIC UTILITIES
XLU S&P UTILITIES SECTOR SPIDER
IGE GSSI S&P NATURAL RESOURCES INDEX iSHARES
IYM DJ US BASIC MATERIALS iSHARES
VIS VANGUARD INDUSTRIALS ETF
XLB S&P BASIC INDUSTRIES SPIDER
XLI S&P INDUSTRIAL SECTOR SPIDER
XME S&P METALS & MINING SPDR
MOO MARKET VECTORS AGRICULTURAL ETF
IYT DJ US TRANSPORTATION AVERAGE ETF
And here are the current upside vs. downside price change forecasts implied by market-maker hedging activities:
(used with permission)
In the above mapping, ETFs with more attractive buy prospects are down and to the right, while scarier propositions are above the diagonal line, that space where price change directions appear of equal potential. Note that the diversification effect of many holdings in a fund tend to limit the size of overall change expectations, in both directions, up and down.
From this single criterion, IYW at , a technology sector ETF has the advantage of virtually no downside exposure, and 6-7% upside prospect - at its current price, at this point of appraisal. Further examination reveals that few previous instances of this nature exist, so it is difficult to know how the future may play out.
These are not long-term economic forecasts of where the economic sectors are likely to go. They are price change possibility forecasts, specific to the individual ETF. Experience shows that they are most useful in a 4-6 month outlook period.
Each ETF's current forecast is compared to every daily forecast in the past 5 years to find how subsequent market quotes evolved. A standard test of how long it took to reach the price range high of the forecast, or if not reached in 3 months, what average gains were achieved, including closeouts at 3 months. Also noted are the percentage of profitable experiences, the average holding period and the annual rate of return achieved by these prior like experiences.
The worst-case price drawdowns following the forecasts are also averaged. Importantly, investment risk is NOT properly measured by volatility of price, which also includes upside variance from its mean, but is instead the exquisite discomfort experienced by being in a losing-money position. That is when investors are far more inclined to do dumb things than when they are ecstatic about how smart they have been to get so far ahead.
To provide some perspective, here are averages of the ETFs by sector focus. First, their upside price change forecasts, in contrast with their average prior worst-case price drawdowns during the 3 months following the forecasts.
It turns out that in every case, larger drawdowns have been the case, on average, than are the current upside prospects for each set of sector ETFs. Perhaps this may be a poor time in general to use these ETFs, regardless of their particular focus, because of their current prices.
Still, in comparison with the average of all stocks and ETFs, these Sector Funds, in most cases, show less drawdown exposure than individual issues. The reduced return prospects may simply be part of the cost of diversification.
A further comparison of the Sector returns from prior forecasts, with upsides to downsides like the present forecasts, is pictured below. In it, a benefit of diversification is apparent in that the odds of achieving a profit (the blue columns) are better in any of the sector funds than in the average of all individual stocks and ETFs (at the far right). We know that high odds for profit is one of the more important factors in generating attractive rates of return. This is an obvious illustration of the trade-off between higher returns and lower chances of getting them.
When we look beyond just the simple size of typical gains from Sector ETFs, a disadvantage appears. The slightly higher average gains from the sectors require enough longer commitment of capital than is required by single stock positions, so that their annual rates of return now fall below the rates for individual equity holdings. So the investor is left with the choice between faster wealth accumulation, or more enjoined discomfort in the process.
The poor showing by the Utilities Sector ETFs remind us that diversification as a risk management tool is not infallible. Two out of the three ETFs in this set had losing investment results from prior experiences following hypothetical buy commitments at forecasts of upside to downside like those seen today, pulling the set into negative territory.
Utilities have had a severe underperformance of the S&P500 index over the past few years. It shows up clearly in the preceding picture, so perhaps we should not be surprised.
Here are the price range forecasts and comparative performance test scores for each of the sector ETFs individually, along with averages for the group at the bottom, and a contrast of the population average of all stocks and ETFs.
We have in our last few ETF articles cautioned that this has looked like a poor time to be investing in most ETFs to achieve price gains, with some exceptions. That notion has not changed, but is always sensitive to price movement.
Additional Disclosure: The author has an investment interest in the website blockdesk.com which, while not yet open to the public, is in conversion from being a delivery medium of information to institutional investors to a new life of providing similar help to do-it-yourself investors. Both brief and extended-time subscriptions for single or multiple issue inquiries should be at quite reasonable and manageable costs for individuals. Announcement of its opening is hoped for in the 4th quarter of this year.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.