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Courtesy of Daniel Sckolnik, ETF Periscope
“Get your facts first, then you can distort them as you please.” — Mark Twain
What exactly are the equity markets on, anyway?
Really. When you consider the underlying fundamentals to the U.S. economy right now, the fact that the just-completed first quarter yielded such strong results has to give one pause. The thing is, the current market doesn’t seem to have a pause button to hit.
Looking at some of the benchmark Indexes, it doesn’t take a whole lot of attention to recognize the trend. The Dow Jones Industrial Average (DJIA) gained 6.4% for Q1 of 2011, its best quarterly percentage gain in over 11 years. The benchmark S&P 500 Index (SPX) ended up over 5% for the same quarter, and the Nasdaq Composite Index (NASDAQ) clocked in at 4.8%.
These are staggering numbers in light of the global shocks experienced over the course of this same time frame. It would seem that Japan’s horrific travails, the chaos resulting from the wave of pro-democracy activities in the Middle East, and the continued weak performance of the U.S. housing markets would combine to serve as a damper to the exuberance that the markets have recently demonstrated.
It would seem. Yet it has not.
The question to ask is, what exactly is making the markets so robust?
Is it a deep, abiding belief that growth is inevitable? Or, on a slightly more cynical note, is it possible that the big players in the markets are taking advantage of the Fed’s largesse in the form of QE1 and its subsequent sequels, and the markets are being pumped up on things of a non-fundamental kind?
Needless to say, there is not a consensus answer to this question, only fragments to be discerned by each investor. Who said figuring the markets is easy? Still, the continued influx to equity markets remains a bit of a baffle, though there is hardly a shortage of opinions as to the reason.
If you are looking for an additional indicator of relative complacency in the equity markets, one may be found simply by glancing at the VIX chart. The VIX, the Chicago Board Options Exchange Volatility Index, measures the expected volatility in markets using options on the S&P 500 Index. The VIX rises as traders seek out protection from down-bound markets. As of late Friday, the VIX was at $17.40, which is well toward the low side of the $15-30 range it has traversed over the course of the last nine months. More greed, less fear. Another way to put this is that currently, the appetite for risk is continuing to occur. The equity markets are apparently a recipient of this sentiment, at least for the moment.
What’s occurring in commodities right now, on the other hand, makes a certain degree of sense.
Gold, ending the week at $1,428, continues on its rampage, though not quite as parabolic as it did back in the 2nd and 3rd quarters of last year. Again, this trend makes sense. Adding gold to sovereign funds across the globe has continued at a steady clip for the last couple of years, and there really is no reason to suspect that governments worldwide will suddenly decide to dump a commodity that fulfills so many purposes, including as a counter to the growing risk of inflation. Though it is hardly the only reason that the metal continues to hover close to its record highs, it certainly provides a substantial underpinning.
It must be mentioned, however, that when you read about hotels in Abu-Dhabi that feature gold-dispensing ATMs, it’s a little difficult not to conjure up visions of Holland back in the days of the Tulip mania.
What about oil? It broke past the $107 per barrel level this past week. Unless and until another significant global financial meltdown occurs, oil remains attractive to the speculators who impact that market in a big way. The ongoing wave of political unrest and economic uncertainty in the Middle East and Northern Africa virtually assures those same speculators of a lucrative playing field as they ride the dual waves of fear and greed up and down the price slope. And, with infrastructure needs continuing to grow on an international level, oil will continue to be a commodity in demand, unless, as mentioned, a severe reversal of the growing global economy, however slight and slow, occurs.
It’s pretty unlikely that the markets are expecting a whole lot out of Washington. The battle of the budget in Congress seems pretty fierce, but investors seem to be unconcerned by that hoopla, owing, no doubt, to their recognition that whatever budget cuts do eventually get enacted, they will represent a relatively insignificant amount of the federal budget deficit. So, as is the norm for Washington, it is a lot of noise for little effect. A miniscule budget cut will hardly impact the economy in any meaningful way. It would likely take a much larger action than will likely occur, such as the government getting more tax revenue. But that hardly seems like a reality due to the politics of it all.
Sort of like filing shavings from a copper penny and claiming that will impact the value of a paper dollar.
What the Periscope Sees
In spite of the Bullish determination that is reflected in the current uptrend, regarding the markets through cautious eyes right now just makes sense. Utilizing a “pairs” strategy as a method of hedging your bets is one way to attempt to catch some profits off the “updraft” while keeping your hands on the downside brakes simultaneously. The thinking goes like this: pick the best that you feel the market has to offer, and combine it with the weakest equities you can find. This creates a “pair” that, theoretically at least, should work in your favor in a trending market, profit-wise and hedge-wise.
One of the tools I use in evaluating ETFs is Sabrient’s ETFCast Rankings. It consists of over 300 ETFs (exchange-traded funds) that are ranked and scored via nineteen of Sabrient’s proprietary analytics, that, when taken together, offer a forward-looking take on the markets.
I generally scan down the current list of the top ETFs, choosing no more than one per sector, in deference to the concept of diversification. I’ll also look at the ETF’s chart, taking note of certain reference points, including support and resistance levels and simple moving averages.
Here are two pair trades worth considering.
Both PRN, in the Industrials sector, and KOL, in the Energy sector, are within the top 10% of the rankings, and have strong fundamental and technical elements in their favor. These are the Bullish recommendations.
On the flip side, RTH, in the Retail sector, and KCE, in the Financials sector, reside in the bottom 10% of the same rankings, and serve as the Bearish choices for this model.
These four ETFs can be configured into pairs of either PRN/RTH and PRN/KCE or KOL/RTH and KOL/KCE.
Pair away at your leisure. In the meantime, here’s the lowdown on each of these ETFs.
PRN (PowerShares Dynamic Industrials Sector Virtual Portfolio Fund) is based on the Dynamic Industrials Sector Intellidex Index. The Fund will normally invest at least 90% of its total assets in common stocks that comprise the Index. The Index thoroughly evaluates companies based on a variety of investment merit criteria, including fundamental growth, stock valuation, investments and risk factors. The Fund seeks investment results that correspond generally to the price and yield (before the fund’s fees and expenses) of the target index.
KOL (Market Vectors Coal ETF) is an exchange-traded fund launched and managed by Van Eck Associates Corporation. The fund invests in stocks of companies across the globe and all market capitalizations that operate in the Coal and Mining Industry. It seeks to invest its corpus in stocks of companies that form the Stowe Coal Index in proportion to their weightings in the Index. KOL seeks to replicate as closely as possible, before fees and expenses, the price and yield performance of that Index.
RTH (Retail HOLDRS Trust) is an equity exchange-traded fund launched and managed by Merrill Lynch. The investment offers diversification in the retailing industry through a single, exchange-listed instrument. The trust holds securities issued by specified companies that, when initially selected, were in the retailing industry. There are currently 20 companies included in the Retail HOLDRS Trust.
KCE (SPDR KBW Capital Markets ETF) is an exchange-traded fund launched by State Street Global Advisors and managed by SSgA Funds Management, Inc. The fund invests in stocks of companies operating in the Financials Sector. The fund replicates the KBW Capital Markets Index (Ticker: KSX) by investing in the companies of that Index in approximately the same proportion and, before expenses, seeks to closely match the returns and characteristics of that Index.
Don’t be too surprised if what occurs this week in the markets serves as a tone-setter for the 2nd quarter. It really is a fulcrum point right now, so keep eyes wide.
