Is The Shipping ETF About To Hit An Iceberg?

Feb.21.12 | About: Guggenheim Shipping (SEA)

While many sectors have come back with strong performances in the post-recession world, others are still struggling to find their footing in the new economic environment. One sector in particular that could remain weak is the shipping segment, as this corner of the market remains heavily dependent on broad economic trends and strength in multiple markets in order to buoy companies in the space.

In fact, those that have been invested in the main ETF tracking the industry have likely been extremely disappointed with the long term performance of the fund. The Guggenheim Shipping ETF (NYSEARCA:SEA) plummeted by nearly 44.2% over the course of 2011 as fears over a slowdown in China, oversupply among ships, and a possible recession in Europe conspired to push investors out of this product throughout the course of the year. Additionally, it didn’t help that nearly 12.4% of the product is in Greek stocks while another 29.1% are Japanese companies, two countries that didn’t exactly have an outstanding year, to say the least. (read Global X Debuts Greek ETF)

Thanks to these factors, expectations for SEA were definitely low heading into 2012, even though the product has a P/E below 8 and a P/B less than 0.7. Possibly thanks to these value characteristics, many stepped in to scoop up the shipping ETF to start the year, pushing prices of the fund up by nearly 21.4% since the beginning of January. This incredible surge was undoubtedly boosted by declining fears over the economic situation in both Europe and key emerging markets, while stronger data in the U.S. also helped to spark more interest in the space. Yet, despite this solid performance to start the year and the deep value inherent in many of the securities in the fund, there are significant risks that still remain for the sector (see Top Three High Yield Global Sector ETFs).

First and foremost, is the shocking performance of the Baltic Dry Shipping Index over the past few months. This benchmark, which is a measure of the costs to ship raw materials by sea, has pretty much fallen off a cliff over the past few months, leading many to believe that more pain is ahead for the industry. In fact, the index has lost about two-thirds of its value since mid-December, pushing the benchmark to a 26-year low, surpassing even the level that investors saw in the height of the recession in December of 2008 (read Are Telecom ETFs In Trouble?).

Given this catastrophic performance in this key index, Fitch Ratings has declared that they expect an increase in the number of distressed shipping firms over the next year, suggesting that a further shakeout of the industry could be at hand. Thanks to this, investors should proceed with caution when looking at making an investment in SEA at this time. While the product could continue to soar, rocky seas could be ahead for many of the funds’ components, especially if the Baltic Dry Shipping Index remains depressed. As a result, it may be ideal to wait until the benchmark truly bottoms-out before purchasing SEA or at least waiting until we see a correction in the space. After all, the shipping industry isn’t going anywhere as a whole and deep value is still inherent in many of the securities in the fund, suggesting that waiting could be the best course of action in this troubled sector in 2012 (read Three Outperforming Active ETFs).