ETF Update: Greater Flexibility, More Strategies

The diversity of new ETF offerings offers many more choices for the investor.  Back in the old days, say a year or two ago (!), only professional traders engaged in short-selling.  Only the pros or those with major business interests did commodities trading, and currency speculation or hedging.

It is not your father's market....

ETF Strategies

Going short the market has gotten a lot of attention in the last week.  Our regular readers know that we have also featured the deteriorating sector breadth and noted the rise in our strength ratings for "inverse" ETFs.  Tom Lydon's excellent ETF Trends raises the bidding with this article about a "triple threat" to the market.  Tom cites three ETFs that are not just short, but leveraged shorts:

 

It's no wonder that some short ETFs have been popular with investors this year. Some of the strongest performers include:

• ProShares UltraShort Financials (SKF) , up 41.1% year-to-date;
• ProShares UltraShort Health Care (RXD)  , up 30.8% year-to-date;
• Rydex Inverse 2x S&P 500 (RSW) , up 18.3% year-to-date.

 

These are, of course, the ETFs that will decline the fastest in a market rebound.  We have been sticking to the single-weighted shorts, with a maximum positions size of 3 out of a possible 8 holdings.

Bottom fishing is a natural trading impulse to maximize returns by guessing the bottom in a sector.  ETF trading makes this approach easier.  The idea is to look for a beaten-up sector that seems to have value.  Instead of detailed stock analysis, these moves often seem based upon "feel" or instinct.  We know several traders who have attempted to call the turn in financial stocks.  So far, every such move has been wrong.  Last week saw a number of additional downgrades for financial stocks.

One danger in a lazy approach is clear from this nice analysis by Saj Karsan.  He takes a look at the popular homebuilder "spider",  (XHB).  He posits that one might think the group was attractive on a book value basis.  After looking at the components, he points out that one is getting plenty of retail and mortgage stocks, not just the builders.  Also, the best stocks on book value are not included.

Our Take

Any beaten-down sector will have a bottom.  Whoever predicts it on the right day may seem like a genius.  Since there are plenty of predictions, someone is sure to be right.

We prefer to find some catalyst, whether fundamental or technical.  We miss the first part of a rebound, but participate in big moves.

 

Weekly TCF-ETF Rankings

Our weekly ratings (more information at the end of the article) go from Thursday to Thursday.  Last week we noted that inverse ETFs were highly ranked and worth owning.  That position helped our performance last week.  The combination of oil, basic materials, and index shorts had a solid gain in a week where the market declined sharply.

The overall rankings remain similar, but some sectors are close to a "sell signal."

Here is the chart for the most recent trades and current ratings as of Thursday's close.  As one can see, financial stocks are firmly at the bottom of the list.

 

 

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  Before turning to the current rankings, let us undertake a review for readers new to this series.

Our Method.  In this past article, we described our basic methodology and why we believe the rankings are useful for fundamental traders and technical traders alike.  While we urge readers to check out the entire article, the key point is that ETFs pose challenges and opportunities different from investment in individual stocks.  The fundamentals may be more difficult to assess.  Even with a good grasp on fundamental trends, there is a lot of technically-based trading in ETFs.  This means that those trading with a fundamental approach (and we do this as well) want to monitor the "hot money" moves.  Here is an article on that point.

The system synopsis. We look at Trending sectors, Cyclical Sectors, and build in an element of Anticipation for both entry and exit -- thus the name of the model, TCA-ETF.  While we do not reveal the exact methodology for spotting trends and cycles, the system is not a "black box."  The basic elements are used by many, and widely reported.  We even discuss the need for human analysis as opposed to black box trading.

We report the rankings each week, now on the weekend with a one-day delay, using the Thursday output from the model.  We monitor and trade this daily, and offer a free report  (request via the email address on the top left of the site) for those interested in our weekly trading program.

 

Comments

[nearos]

I remain impressed that several important and highly traded ETFs (such as DBC RJI DBE RJN GAZ DBA MOO EWZ ILF GLD SLV PHO) are not included in your analysis. Can you please explain why?

[Jeff]

nearos -- We do have a couple of the ETF's you mention. The universe we use is part of an overall trading strategy where we remain invested in the top eight sectors. We do not want to have, say, eight Latin American country funds, or eight gold and silver ETF's. For this reason we choose a representative ETF for a particular theme. We look for open-ended funds without excessive concentration in a few companies. At the moment, we have not included pure commodity plays, but the idea is under review. It may require a completely separate ranking and asset allocation.

We publish the ratings for the general interest and to give a look at our strategy. It is not intended as a comprehensive comparison of all funds. If your favorite ETF is not on the list, you should be able to find a similar ETF in our universe, and the strength ratings will probably be similar.

We consider (and use) suggestions for new candidates that meet the criteria. We also provide reports to some customers who have their own customized list of candidates.

Thanks for your comment. I'm sure that others had the same question.

Jeff