Are Today's Leading ETFs Lagging Indicators?

The Investor's Business Daily asks for my feedback on a regular basis. I am particularly fond of Trang Ho, who happens to cover the exchange traded universe for IBD.

Trang recently wrote a piece that highlighted the strength of the Consumer Staples ETF (XLP) relative to the S&P 500 over the prior 12 months. XLP is up 8% in the time frame while the S&P 500 is down 10% from a year ago.

The numbers are accurate. The info is sound. Yet the title of the feature, "Consumer Staples ETF Leads Amid Uncertainty," may actually lead investors down the wrong path.

Why do I say that? In essence, the stock market prices in "bad times" as much as 9 months in advance of the recessionary reality. The time to get excited about consumer staples is at the tail end of an expansion, not in the valley of darkness.

For instance, one of my favorite holdings that I discussed in detail over the previous 12 months has been Global Consumer Staples (KXI). I began acquiring the position in late May of 2007... and a bit more during the summer of 2007 when sub-prime became mainstream.

(Remember last summer? The sell-off was beginning to take on epic proportions until the Fed stepped in with an emergency discount window rate cut.)

I sold KXI during the January market swoon. My stop-losses had hit. And even consumer staples were rather troubling.

Nevertheless, we pocketed roughly 10% in profits on the position. Why? Again, the best time the acquire staples is during the end of an economic expansion... not in the middle of a contractionary phase.

So what might one be purchasing in a contractionary/recessionary/stagflationary economy? Investors should be looking for company types that suffer horrendously in a bad economy.

Keep in mind, the S&P tends to peak 6 months before a recession begins, and it tends to move higher once the contractionary phase has hit a mid-point. Since October 9 is generally recognized as the peak, that would mean April 8 marked an unofficial beginning for contraction. (GDP Q2 actually showed anemic growth, but let's still call it "bad" enough.)

We may not be able to predict where the mid-point/lowest ebb of the "bad" economy is. Yet we do know that they've been averaging about 1 year since the 40s, although there's nothing that says it can't go for 2 or 3 years. We know that the average bear in stocks also lasts 12 months.

This puts the mid-point of the really bad economy... potentially... in October. It also puts the average bear concluding in... yep... October.

And to add a bit more historical perspective, October is known as the "bear killer" in the Stock Trader's Almanac.  The month of October has marked the end of 9 major markets, including, 1974, 1987, 1990 and... arguably, October 2002.

Am I going out on a limb to predict that the bear will officially end this October, 2008? Nope! Predictions are foolish. And nobody, but nobody, has ever nailed future events consistently. (I found the "Jim Cramer: 1 Out Of 10 Aint Bad" video rather amusing.)

My point, however, is to suggest that one avoid consumer staples at this point. The reason is simple: The greater likelihood is that we've been closer to the bottom at S&P 1200 than we are closer to the top at S&P 1565.

Based on probability alone, you're going to want to consider the areas that have already suffered the most. The smallest companies, for instance, have had it far rougher than the S&P 500 SPDR Trust (SPY) since October 9, 2007. And yet, the iShares MicroCap Index (IWC) has almost made the round-trip to pull even with the large cap proxy.

Indeed... I am suggesting that you look closely at an eventual allocation to IWC or the iShares Russell 2000 (IWM). The small-caps have already climbed above long-term trendlines (200-day moving averages), an indication for many technicians to purchase.

(Read more on micro-cap ETF investing right here!)

Another "crazy" idea is to buy the George Costanza "opposite" of staples; that is, you might consider the Consumer Discretionary SPDR (XLY) as you feel more comfortable with the idea of buying mauled cyclical companies in the middle of terrible economic times. XLY is certainly trying to get above that elusive 200-day line.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Comments

[dg arc:]

I am not entirely sure that
1. Oct is the mid point of the downtrun
2. Oct is the stock market bottom

Good insight, and maybe good judgement too. lets see

2008 Aug 15 10:09 AM