The Delta Factor Indicates Positive Outlook for VFH

 |  About: Vanguard Financials ETF (VFH), Includes: VIS, VOE
by: Lowell Herr

Of the 11 Vanguard sector ETFs, which one is showing the highest probability of performing well over the next few months? Before answering the question, note the key assumptions employed in this analysis. 1) The S&P 500 is projected to grow at an annual rate of 7.0% over the next year. This assumption impacts the future projection for each sector ETF shown below. 2) A four-year time frame was used for this analysis displayed in the first screen shot. Readers will remember that in August of 2007 the market was moving toward an October high.

For comparison purposes, the second screen shot shown below uses a three-year time frame. In August of 2008 the market was in the middle of a major bear market. It is useful to use different periods, particularly during volatile markets to test the viability of the "Delta Factor."

Of the 11 sector ETFs, financials (NYSEARCA:VFH) provides the highest probability of success over the next few months to a year. How might one use this information? Rather than thinking of the "Delta Factor" as a market timing tool, consider it to be a probability tilting or rebalancing tool. Assume one builds a portfolio around sectors. My preference is to use asset classes, but for this example, I am using sectors. Due to the poor historical performance of VFH, there is a high probability this sector is under target. If that is the situation, now is the time to begin adding shares of VFH to the portfolio so as to bring the financial sector back into balance.

If the financial sector is in balance and cash is available, one might want to overweight this sector, a tactical sector probability bet.

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The following screen shot uses a three-year period for the analysis. While the financial signal is not quite as positive as it is with the four-year analysis, nevertheless, the Buy signal is still in place for VFH.

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Click to enlarge
To learn more about the "Delta Factor," go to this site to see what projections looked like during market inflection points. It is not unusual for the "Delta Factor" to be a leading indicator in that Buy signals are known to crop up several months before the market hits a bottom. In addition, the "Delta Factor" algorithm is designed to keep investors in the market. Buy and Sell "Delta Factor" signals are not common. A "Sell" signal is used to lower exposure to a particular sector, not to sell the sector completely.

Based on current data, Financials (VFH), Industrials (NYSEARCA:VIS) and Energy (NYSEARCA:VOE) are best positioned to respond to market movements over the next few months, with VFH the undisputed leader.

Disclosure: I am long VNQ, VFH.