ETF Update: The Financial Rebound

In the midst of extreme volatility, financial stocks have shown some relative strength.  Some have described this as a rotation out of the popular hedge fund position:  long energy, short financials.  There are many different ETF choices related to financial sectors.  Two weeks ago we highlighted the rise of these sectors, featuring regional banks (IAT), but the strength ratings were relatively modest.  This week our ratings show strength in the 100 range.  Sectors with this rating are forecast to perform in the top two percent of historic sector returns over the next month.  (For new readers, there is a further explanation of our approach at the end of the article.)

As usual, we shall look more deeply into the fundamental factors that underly this change in strength and consider the implications for the overall market.

Dow Jones U.S. Financial Services Index Fund (IYG)

Our featured ETF this week is the iShares Dow Jones U.S. Financial Services Index Fund (IYG) .  It includes 135 securities split 60-40 between banks and financial services companies.  The top five holdings constitute 40% of the fund including Bank of America (BAC), JP Morgan Chase (JPM), Citigroup (C), Wells Fargo (WFC), and Goldman Sachs (GS).  The P/E ratio is 15.6, book value is 2.15, and a beta of 1.4.

Earnings reports from Freddie Mac (FRE) and Fannie Mae (FNM) affected the group this week.  Estimating the extent of further markdowns and write offs of assets is a continuing challenge.  Both Fannie and Freddie disappointed with their reports, weighing on the other major financial companies.

Another factor is the continuing story about Auction Rate Securities.  As Tom Lydon noted early in the week, the New York investigation of Citigroup posed a challenge for many financial ETFs.  With the announcement of the settlement, Citi traded lower and there was speculation about the impact on other firms that had offered these securities.

Writing in Barron's, Jacqueline Doherty has a nice summary and analysis of the current state of the ARS problem.  There is a wide range of security values depending upon the original issuer.  Also, some of the dealers have developed alternative structures to help in restoring liquidity.  The large dealers might choose to (or be forced to) repurchase the securities at a loss, perhaps pending the development of new structures.

We agree with this conclusion from the article:

"This is a relatively low-cost political settlement," says Brad Hintz, a brokerage analyst at Sanford C. Bernstein. Buying the securities won't help the firms' efforts to shrink their own bloated balance sheets, but even at Merrill, the $12 billion of auction-rate securities it agreed to purchase is tiny relative to its balance sheet of about $1 trillion.

When prices get low enough, investors sometimes see value despite the mixed fundamental picture.

Weekly TCA-ETF Rankings

There were no trades this week.  The positions have done pretty well in a very difficult market.

The fraction of sectors in the "penalty box" is now about half, a great improvement in the overall picture.  The overall market indexes have pulled significantly ahead of  the inverse index ETFs.

Using the model as our guide, we shifted from our recent "neutral" forecast to "bullish" in the Ticker Sense blogger sentiment poll.

Listed below are the week's rankings and our trades:

Click to enlarge

 

 

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETFs 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.