Examining Equity Markets Using The 'Delta Factor'

by: Lowell Herr

Which equity ETFs have the greatest probability of doing well over the next six to 12 months? The following analysis looks at both a three- and five-year history of a variety of equity ETFs. One set of "Delta Factors" takes in the last bear market, while the three-year analysis begins after the bear released its claws.

Three-Year Delta Factor Projections: "Grim" describes future projections when one uses the past three years of data to come up with Delta Factor projections. This is not surprising for the following reasons. The market nearly doubled since March of 2009. When this happens, Quantext Portfolio Planner (QPP), using a reversion-to-the-mean calculation, will project future returns at a lower percentage than past performance -- at least in most cases, as readers will observe below. Since the "Delta Factor" projections are based on both historical and future projections and the future projections are lower than historical values, the probability of doing well in the future is lower. That should make common sense. Markets do not rise to the sky, although this one has come close.

We need to experience a cooling-off period. Most likely, we will see a rather flat market until after the election, and it may appear rather dormant until the economy picks up at a faster rate. The following table is not filled with optimism.

Looking at the current Delta Factor conditions and using three years of data for the analysis, the signal is to be patient. One can do some rebalancing around the edges, but this does not appear to be a good time to throw significant dollars into the equities market. At least that is what the "Delta Factor" probability argument is signalling.

(click images to enlarge)

Five-Year Delta Factor Projections: This situation appears to be a bit more positive if one uses five years of data. Using a time frame that incorporates the Great Recession, we come up with five international ETFs that have a good probability of doing well over the next six to 12 months. Based on the following analysis, I would keep international real estate -- the SPDR Dow Jones International Real Estate ETF (NYSEARCA:RWX) -- and international markets -- the Vanguard FTSE All-World Ex-US ETF (NYSEARCA:VEU), Vanguard Europe Pacific ETF (NYSEARCA:VEA), Vanguard Emerging Markets Stock ETF (NYSEARCA:VWO), and iShares Dow Jones EPAC Select Dividend Index ETF (BATS:IDV) -- on target based on the Strategic Asset Allocation plan.

Don't pay too much attention to the Vanguard FTSE All-World Ex-US Small-Cap ETF (NYSEARCA:VSS), as this ETF does not have five years of data. I have concerns about holding iShares Silver Trust (NYSEARCA:SLV) as the probability is low for doing well over the next few months. However, probability arguments aside, these projections are made to be broken.