Seven ETFs To Watch? (ETFs: XLE, IVW, PKB, GLD, XLF, EEM, PRF)

by: Roger Nusbaum

Roger Nusbaum submits: MarketWatch has an article up with the above title (I added the question mark). The article isolates seven funds that either might or should (depending on how you read the article) do well in 2006. Here they are:

ETF 2005 return
Energy Select Sector SPDR XLE 39.6%
iShares S&P 500 Growth IVW 4.6%
PowerShares Dynamic Building & Construction Portfolio PKB n/a
StreetTracks Gold Trust GLD 17.5%
Financial Select Sector SPDR XLF 6.8%
iShares MSCI Emerging Markets EEM 32.7%
PowerShares FTSE RAFI U.S. 1000 PRF n/a

I think this list focuses an awful lot on what was hot. Growth over value is something a lot of people have been calling for in the new year. I would have liked to have seen more 'what can go wrong' analysis with these funds because after such big and prolonged moves, that becomes the concern.

I think energy will continue to work very well but a move to $40 is possible (I think unlikely) and if it happened would hit energy stocks aggressively.

Growth usually outperforms value in a flattening curve environment and also toward the end of an economic cycle. By that precedent, growth should have done better in 2005 that it did. I buy into the logic of why growth should lead; I'm not sure it will just turn on all of a sudden.

I have not understood the supply and demand for new houses in the past and I still don't. I will say that the argument that these stocks are cheap at eight times or ten times or whatever is not a good argument. These stocks always trade at single digit multiples. If that is normal then it is normal not cheap.

I think gold will do well, $600 well but not $800 well, but there is probably a lot of fast money in there that could be easily shaken out. I would not be shocked to see more volatility with gold in 2006 than there was in 2005. It makes sense that a lot do-it-yourselfers may not really have a feel for the potential volatility.

The financial sector is a contrarian play. One I'm not making (meaning that I will remain underweight the sector compared to the S+P 500). Most clients have one domestic financial with the rest being in foreign bank stocks. I may look to add a little capital market sub-sector exposure fairly soon.

The emerging market theme seems alive and well to me but its duration of outperformance may have about run its course based on precedent. I don't know if that will matter in 2006 or not but it is worth knowing. I think the emerging markets that offer natural resource exports might be more stable as I think demand will be strong for a while to come.

The RAFI is interesting. It is large cap but screened to weight companies quantitatively rather than by market cap. Apparently it beats the SPX in every type of market condition. The way it works out, the RAFI is tilted more to value and small cap. If you are thinking about buying this one you may want to compare it to a small cap value ETF. Even though it owns all the mega caps, if it correlates to small cap value then you should know that.

As I was writing this post I had a comment left about RSP beating SPY as a validation for Arnott's methodology. RSP, by virtue of being equal weight, has a smaller median cap than SPX. The next time the mega caps lead the market (and they will again at some point) RSP will lag SPY.

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