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Summary

  • Relative strength analysis of the market rotation in the aftermath of the Thursday equity sell off shows surprising results.
  • Country ETFs may offer more opportunities in the current market environment than sector ETFs.
  • The weakest sector and country ETFs may continue to fall and should be avoided.

The suddenness of the equity sell off last Thursday surprised many investors. Increased geopolitical risks and mixed signals about the U.S. economy triggered the sell off, but the extent of the drop in equity prices was unexpected. The most visible change was that investors looking for a safe haven rotated into long-term Treasury bonds and stampeded out of growth stocks and high-yield corporate bonds.

The sell off was broad based, but not all equity sectors were effected by the same degree. The late Friday afternoon rally gave us new hope that the markets will stabilize this week. However, we are approaching the fall season which has often brought increased volatility in the history of the stock market.

To prepare for a potentially dangerous period, it is important to make a clear assessment of the changing market dynamics in the aftermath of the Thursday equity sell off.

What are the strongest sectors that can provide new investment opportunities in the coming weeks? What are the weakest investments that investors are best served to avoid until markets stabilize? To answer these questions I used Comparative Relative Strength, a time tested approach that allows the evaluation of the trend of a given ETF vs. the S&P 500 index. Using quantitative tools (courtesy of ETFnext.com) I screened 140 sector and country ETFs to identify investments that are the least and most effected by the market sell off.

Sector ETFs with the weakest relative strength

The weakest three sector ETFs are the First Trust ISE Revere Natural Gas (NYSEARCA:FCG), the PowerShares Aerospace & Defense Portfolio (NYSEARCA:PPA) and the PowerShares Water Resources (NYSEARCA:PHO) funds.

The top panel of the charts below show the trend of the Comparative Relative Strength for the ETFs, which is calculated by forming the ratio of the price of the ETF and the benchmark S&P 500 index ($SPX).

The down-trending blue lines indicate, that these investments underperformed the market even before the sell off, furthermore, the underperformance accelerated during the sell off days. These ETFs represent the weakest sectors that are getting even weaker.

The iShares Germany Fund (NYSEARCA:EWG) came out on top, as the weakest country ETFs in the screen. This is not surprising in light of fears about the escalation of the events in the Ukraine that can have a strong economic impact on Germany due to its reliance on Russian oil and exports.

ETFs with the strongest relative strength

The strongest sector ETF in the screen was the iShares Global X Social Media Index Fund (NASDAQ:SOCL). The chart shows that SOCL corrected hard in the March - May period, but was able to regain the earlier positive momentum in May.

While social media stocks can be regarded as a highly speculative sector due to overextended valuations, this industry continues to innovate and expand. The acceleration of Comparative Relative Strength during the market sell off shows that SOCL can provide returns that are uncorrelated with the broadly followed equity indexes.

In international markets two Asian countries, China and Singapore, weathered the drop in U.S. equities the best. While both the iShares FTSE China 25 Index Fund (NYSEARCA:FXI) and iShares Singapore Fund (NYSEARCA:EWS) have gained more than 15% since their March lows, the accelerating relative strength suggests that these ETFs can advance further in the next few months.

Source: Aftermath Of The Equity Sell-Off: The Best ETFs For A Potentially Volatile Fall Season