ETF Update: Back to the Sideline

Sometimes great minds think alike, but often they do not.  In the financial world the leading experts often disagree, especially on specific trades.

Method Matters

Regular readers know that I like to use the sports world for examples, particularly the realm of handicapping.  Let us imagine that we have four different football experts:

  • The fundamental football analyst looks at team strengths and weaknesses, injuries, and the matchups he sees on tape;
  • The "smart money" analyst looks at the line moves in the market;
  • The psychological analyst looks at the schedule to see if this is a "must game" or a possible let down;
  • The modeler runs power ratings and makes his own independent prediction.

The very best practitioners of these methods may all be winners.  On a specific forecast, they may disagree.

So it is with investments.  There are many successful investment methods, including a close parallel for each of the football handicappers.

My Favorite Methods

I described my favorite approaches in this article.  To summarize, I have a long-term perspective that plays upon market themes.  It is a long-only program, but it is not "buy and hold."  I also use short-term trading methods.  Finally, I recommend a dynamic asset allocation program that protects investors against big moves.

Each investor is different, but some combination of the methods works well for most people.

Not surprisingly, the methods sometimes disagree.  Let me look more carefully at the trading approach.

Background

Traders all seek rewards but they
have differing appetites for risk.  It is important to find a method
that suits your personality and needs.  Our short-term trading systems are
basically Trend-following, but also include recognition of Cycles and a
touch of Anticipation.  Since we apply the method to ETFs, we call it
the TCA-ETF system.  We follow two versions of this method, designed for
two clients (Oscar and Felix) with different needs and risk appetite.  [New readers can
find more information about the models at the end of this article.]  For convenience, we have named the models based upon the intended clients.

This Week's Results

Felix, the cautious approach, has moved to the sideline.  This does not mean a prediction for a lower market.  If Felix had that forecast (briefly in place last week), the inverse ETFs would be in the buy range.  Instead, everything is in the penalty box.  Felix just sees the world as too unpredictable right now.

Oscar, the more aggressive approach, is always looking for a way to win.  Oscar is unafraid of the volatility and recommends the short side, holding all three inverse ETFs.  (We do not endorse or use leveraged ETFs).

Individual Stock Analysis

With encouragement from Vince (our modeling expert) I have been looking at individual stocks to see if Felix approves.  The results this week are interesting.

The Dow

Felix is not ready to move on my Dow 20K concept!  Felix has every member of the Dow in the penalty box, although two stocks have positive ratings.  I plan to provide regular updates on this analysis if there is reader interest.  I often use Felix to assist when starting a new position, so this could be a useful assist to those considering dipping a toe in the Dow waters.

The NASDAQ 100

The fussy Felix has assigned 99 of the 100 stocks to the penalty box.  The sole survivor is O'Reilly Automotive (ORLY).  Here is the chart.

Orly

Now here is the fun part.  Tonight on his popular Mad Money program Jim Cramer cited ORLY as a top choice.  Catch this:

First on the list were auto parts makers Advance Auto Parts (AAP),
O'Reilly Automotive (ORLY) and AutoZone
(AZO). Cramer
said this trend makes sense, when things get bad, people keep their cars
longer and fix them up.

Felix was operating on official closing data, without knowledge of the Cramer pick.  This will be fun to watch.  Will Felix and Cramer agree in the future?

Weekly TCA-ETF Rankings

We are currently out of the market in our Felix ETF
program and short for those following Oscar.  (We are happy to
report and discuss performance with
interested investors.  We also offer a report on how we use the models,
and a free weekly email update.  Write to etf at newarc dot com.  Our
actual trading is a
combination of both models and some weekly timing).

As recently noted, I am changing the timing schedule for this weekly article.  It
will now appear mid-week, with a one-day delay in the ratings.  The
ratings below are from Tuesday's close.

Please
note that these are not recommendations.  Investor needs and risk
tolerance
varies.  We hope everyone finds the ratings to be a useful supplement to
their own work.  The recommendations can change quite rapidly in this
environment.

Here are the
current
rankings for
both Oscar and Felix.


Felix 052510


Oscar 052510

Note for New Readers

Our weekly ETF Update is designed to assist both investors and
traders interested in ETF's and Sector Rotation.  We also have free
reports, available
upon request to etf at newarc dot com.  These reports describe how we
use the system, compare results from Oscar and Felix, and contrast the
method with our long-term trading approach.

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 ETF's 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 ETF's.  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.

Oscar and Felix. We follow two
versions of this method, designed for
two clients with different needs.

  • Oscar believes in the long-term strength of the economy and the
    stock market.  He has a lovable and irrepressible enthusiasm.  When
    things go wrong, he steps back for a bit, but soon tries again.  He
    expects to do better than others during good times.  Oscar understands
    that this approach involves more risk.  Oscar is opportunistic.
  • Felix also has a positive long-term outlook, but he is something of a
    fussbudget.  He is much more cautious, with an emphasis on capital
    preservation.  He is perfectly willing to step aside from the market
    when there are signs of danger.  He knows that he will miss some moves,
    but that is OK.  He scores big gains when the market moves lower and he
    escapes the loss.

There is more detail on Oscar and Felix in this article.  There is more about the Penalty Box here.

ETF Update: Can Banks Benefit from Financial Regulation?

(I delayed this article from my regular Sunday posting time since there was so much volatility, perhaps generating misleading signals.  The ratings have been updated to reflect the current situation and do not include the customary one-day lag).

It now seems clear that new financial regulations will soon become law.  Can banks benefit from this development?

Background

Traders all seek rewards but they
have differing appetites for risk.  It is important to find a method
that suits your personality and needs.  Our trading systems are
basically Trend-following, but also include recognition of Cycles and a
touch of Anticipation.  Since we apply the method to ETFs, we call it
the TCA-ETF system.  We follow two versions of this method, designed for
two clients with different needs and risk appetite.  [New readers can
find more information about the models at the end of this article.]

Let
me discuss this week's featured sector before turning to our own
ratings.

Spotlight on the Banks

We
trade banks via the SPDR KBW Bank ETF (KBE).  The ETF tracks the KBW Bank Index.  It has very good diversification — 25 holdings with most in the 4% to 6% range.  A few large banks are higher, but no single holding is over 9%  The forward P/E ratio is over 17 and the trailing is over 20, but the price to book is only 1.01.  The dividend yield is under one percent.  Here is the chart:

KBE may 2010

Fundamental Analysis

Some of the news for the sector relates to the financial reform bill.  ETF Daily News opined that changes in the bill were favorable to banks.

There is a consensus that the regulations are more significant for large banks.  Even those institutions may have pricing that reflects the pending legislation.  GOP changes have relaxed some concerns raised by the banks, especially those related to cost-cutting as a function of size.

Tom Lydon reached a similar conclusion,  citing a MarketWatch column assessing the regulatory impact.

In my weekly market column I expressed caution about banks because of possible European exposure.  Any improvement in Europe is a positive for financial stocks, so the weekend news was bullish.

Other ETF Experts

We always monitor the
conclusions of other ETF experts when considering a trading position. 
This week none of our sources cited the group on technical grounds.  (It is important to note the absence of support for a position).  It is fair to say that this group is "unloved."

Weekly TCA-ETF Rankings

We are currently fully invested in our ETF
programs,  but there are only a few remaining candidates in the "buy" range.  We are happy to
report and discuss performance with
interested investors.  We also offer a report on how we use the models,
and a free weekly email update. 
(Write to etf at newarc dot com).  Our actual trading is a
combination of both models and some weekly timing.

We usually publish the ratings list as of
Thursday's close in our weekend update, a one-day delay.  Given the wild market gyrations from the last few days, I felt that the Thursday ratings would be unhelpful and perhaps even misleading.  Instead, I delayed the article for a day.  I am also including today's current ratings.

Please note that we are not
recommending these sectors, since investor needs and risk tolerance
varies.  We hope everyone finds the ratings to be a useful supplement to
their own work.  The recommendations can change quite rapidly in this environment.  I would not be surprised to see every sector in the penalty box in a few days.

Here are the current rankings for
both Oscar and Felix.  It is interesting to note that Oscar is even more negative than Felix.  While we are mostly following Felix, fans of Oscar should note that the inverse ETFs have positive ratings.


  
Felix special 051010


Oscar special 051010

Note for New Readers

Our weekly ETF Update is designed to assist both investors and
traders interested in ETF's and Sector Rotation.  We also have free
reports, available
upon request to etf at newarc dot com.  These reports describe how we
use the system, compare results from Oscar and Felix, and contrast the
method with our long-term trading approach.

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 ETF's 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 ETF's.  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.

Oscar and Felix. We follow two
versions of this method, designed for
two clients with different needs.

  • Oscar believes in the long-term strength of the economy and the
    stock market.  He has a lovable and irrepressible enthusiasm.  When
    things go wrong, he steps back for a bit, but soon tries again.  He
    expects to do better than others during good times.  Oscar understands
    that this approach involves more risk.  Oscar is opportunistic.
  • Felix also has a positive long-term outlook, but he is something of a
    fussbudget.  He is much more cautious, with an emphasis on capital
    preservation.  He is perfectly willing to step aside from the market
    when there are signs of danger.  He knows that he will miss some moves,
    but that is OK.  He scores big gains when the market moves lower and he
    escapes the loss.

There is more detail on Oscar and Felix in this article.  There is more about the Penalty Box here.


Weighing the Week Ahead: Fixation on the Fed

The “Week Ahead” series is a relatively new concept for me.  I have only been doing it for a few weeks.  It is “thinking out loud” since it is work I always did anyway.  I am open to suggestions.

There are many good services that do a complete list of every event for the upcoming week, so that is not my mission.  Instead, I try to single out what will be most important and help investors think about it.  My theme for the week is what will be the big story for print media and financial television.  It is what I am looking for, and maybe you should as well.

So far, my weekly guess about what will be important has been pretty accurate.  This week I foresee another bout of Fed Fixation.  It is a light week for the economic calendar and I do not expect much on the political front.  On Tuesday afternoon we will see the minutes from the March Fed meeting.  The Fed has made some major improvements in transparency over the years.  When I started in the business, you had to infer the result of the Open Market Committee’s decision by watching the New York Fed’s open market operations at “Fed time,” the regular hour for Fed intervention in the marketplace.  It took some experience to interpret what they were doing — system repos, matched sales, etc — and compare it to the Fed funds rate at the time.

The new approach is so much more sensible, both to communicate policy intentions and also to share information about discussion and dissent.

The Bearish Case

To summarize briefly, here are the various bearish positions:

  • The Fed should not even exist, so whatever they do harms the country;
  • The Fed should have allowed  various banks to fail, mortgage lending to cease, and normal commercial lending to end;
  • The Fed has stoked inflation and nothing that they do now can solve the problem;
  • The Fed actions have been totally inadequate to deal with incipient deflation, so we face multiple years of economic malaise, crashing housing prices, and high unemployment;
  • The Fed is “in a box” where any decision will exacerbate some problem.

A Calmer Look

The Fed has stepped in to fill the post-Lehman void in lending.  The expansion in the monetary base was large in the Lehman aftermath, but it has not continued.  The Fed also augmented a near-zero interest rate policy with an array of special lending facilities and direct purchases of securities.  Despite these actions, credit in the general economy remains tight.

The Fed communications have consistently indicated an emphasis on stabilizing and strengthening the economy with little concern about inflation.  There are now the first signs that some members of the FOMC want to prepare to reverse these policies.

“Prepare” is the operative word.  I expect the process of returning to a neutral policy stance to take about two years.  There will be many small, incremental moves along the way to neutral.  This gradual withdrawal of accommodation is not bearish.  It is a sign of strength.

Look for many commentators to fill pages and air time with speculation about the Fed’s exit strategy next week — and for the next eighteen months or so!

Last Week’s Action

Here is my take on the key data from last week.  I make no effort to be comprehensive, nor am I taking a viewpoint.  I will highlight what I found significant, trying to be objective.

The Good

There was some good news.

  • The ISM manufacturing report beat expectations and is consistent with an annualized GDP growth of 5%.  James Hamilton summarized the week’s data with “It looks good to me.”

 

The Mixed

For a change, the economic news was not so bad.

  • The March Employment Report.  The first month of significant net job gains is good news and it generated a positive response in holiday futures trading.  The payroll job gain was better than most expected if one considers the revisions to prior months and the size of the census hiring, only 48K so far.  The household survey has a larger margin of error (400K versus 100K), but it has now registered a net gain of a million jobs in three months.  This might be overstated, but it is probably not zero.

This is only a start.  The unemployment rate of 9.7% did not move, and will not until net job gains are higher.  An improving economy will also attract people back into the labor force.  The unemployment rate is a popular focal point, but not the earliest indicator of improvement.

Mark Thoma cites the same facts, but is discouraged about the prospects for improvement.  For the really bearish takes, you can see a roundup of comments from the usual suspects here.

Our Trading Forecast

Our own indicators are now bullish, and that was our vote in the weekly Ticker Sense Blogger Sentiment Poll. Here is what we see:

  • 87% (87% last week) of our ETF’s have positive ratings.  This is very strong.
  • The median strength is +31 (up from +24 last week).
  • 69%  (down slightly from 80%) of the sectors are in the “penalty box,” showing a continued high level of uncertainty.
  • Our Index Package now has a solid, positive rating, consistent with a gain in the market over the next three weeks.

Investment Implications

With a quiet economic calendar and a lull in earnings, it is time to be flexible.  I continue to pick up health stocks and economically sensitive names on dips.