In part 1 of our commentary, we discussed the current Fundamental Gravity of our “Slowing Drag...
The Watch List Is Your Best Bet
10/10/2011 7:00 am EST
With sector correlation so high at the moment, diversification opportunities are limited, says Dave Fry of ETF Digest. He says that makes it more prudent to track ETF performance, build a buy list, and be patient.
Kate Stalter: Today, I am speaking with Dave Fry, the publisher of ETF Digest. Dave, there has been a lot of conflicting advice in the market lately, just given all the volatility. A lot of advisors are saying it’s better to simply day trade; others maintain that it’s best to stay the course. With your focus on ETFs, what would be your take on the best course of action in the current market?
Dave Fry: Well, right now, we have been sitting in cash, and we have been sitting in cash since the beginning of June, except for whatever Lazy Portfolios we have, and whatever hedged Lazy Portfolios we have…which are fully hedged at the moment. But our trading portfolios have been flat since the beginning of June.
Kate Stalter: Give us a little background on these Lazy Portfolios. Tell us a bit about that.
Dave Fry: Well, we have one that is domestic, one that is growth, one that is growth and income and another that is international.
Then there are four others that have basically the same features, but one extra that is more focused on emerging markets, but all four have hedged features to them. In other words, they have a portion that utilizes inverse ETFs for hedging purposes, which are put on and off strategically.
Kate Stalter: Within the context of this, with your portfolio partially in cash and partially in some of these other investments: What should a retail investor be doing at this moment, do you believe?
Dave Fry: Well that is a matter of choice, of course, but like I said, my most important portfolio to me personally are the three trading portfolios, away from the Lazy Portfolios. The three trading portfolios, as I indicated, have been in cash since June 1. That is my view.
I think the market was giving us an indication on June 1. We use Tom DeMark technical indicators, for example, and they were giving us a very powerful trend-exhaustion signal at the end of May, which is usually pretty reliable. That caused us to go into cash at the beginning of June, which was maybe a couple of weeks premature, but seems to have been the right decision.
Kate Stalter: So essentially, even though there have been a few days of strong upside trade on the markets recently, investors should not get too caught up in the emotion of the particular days, and focus more on the trend?
Dave Fry: It has really been extremely volatile, and it has been as volatile—or more volatile, particularly since August began—than any other period I have seen since 2008. A lot of these day-to-day actions parallel what was going on in 2008 at its worst period.
So clearly, as many people say, Europe is driving the bus. People are very concerned about it, and what kind of contagion it has, and what kind of exposure US banks like Morgan Stanley (MS) and Bank of America (BAC) have toward Europe.
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Of course, our focusing on ETFs, we have over 100 ETFs on our main menu. Those are representative of commodities and currencies, US stock sectors, Europe, single-country funds, and so forth, running the whole gamut.
Probably most the unique feature of this market has been the high level of correlation from one sector to another, away from bonds for example, where everything has been going up at the same time. So you are not getting really the non-correlation that you are looking for to get really real diversification opportunity.
Kate Stalter: I’ve been looking at your blog, and I notice that you do have some watch list ideas, in terms of best ETFs within given sectors, for example. Any particular watch list ideas, over the medium or longer term, that investors or traders might want to take a look at, Dave?
Dave Fry: Well, I think you really have to pay attention to the financials here. There has never been a bull market without financials participating. Financials are in the dumps of all the sectors, US and overseas.
So we have been trying to focus our attention on when financials might turn, and they haven’t turned. We have had a lot of volatility within it, but the overall trend has been down. Particularly, our focus is more on weekly chart analysis than on day-to-day movement.
Kate Stalter: You had written recently about some of the retail ETFs. Anything in there that is a watch list candidate, perhaps?
Dave Fry: It is very true that if you look at the enhanced indexed ETFs, like PowerShares or First Trust for example, you will note that within those retail ETFs, you will get more outperformance on the upside with those. Then you will see the opposite being true on the downside.
With the conventional retail ETFs like the SPDR S&P Retail ETF (XRT) or the Consumer Discretionary Select Sector SPDR Fund (XLY), which is really a consumer discretionary stock but has kind of a grab bag of features in it, which makes it the most popular, just because it is the largest.
XRT is the pure retail ETF, and it is fairly equally weighted, which I think gives you a pretty good picture of what is going on with major retail sectors…without the sector itself being enhanced to try and achieve better results that you would see with others, like in PowerShares and First Trust.
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So what we have done is: We have about 40 different top candidates that we selected, because there are so many ETFs available even within one sector. There might be 30 ETFs in one sector.
So what we have tried to do is break them down to the top ten in each of those sectors, giving people an opportunity to say, “Well, I don’t want to go through all 30 and try to make a choice; let’s just look at ten or so, and then pick something from that.”|pagebreak|
Kate Stalter: But at this juncture, do you believe it is better to be watching them for some technical buy signals and an improvement in the market, rather than jumping in at this point?
Dave Fry: No, I don’t see anything to get you involved in it. Once again, I have to go back to the correlation. Everything is correlated. It is almost just by a degree of difference that you are seeing, but the correlations on the trends are all the same, from one sector to the next.
So it is just the degree of difference, like financials, of course, are in a bear market. The financials have been in a bear market for quite some time. Those trends are the same for retail, except the financials’ trend is much more severe, but it is the same basic overall trend.
I am not seeing anything that people should be getting out there and being long. Even bonds, you have to be selective, so we have a top ten list for bonds.
You have to be careful with the bonds, because with economic data poor, you look at even the investment-grade corporate bonds—like the Investment Grade Corporate Bond Fund (LQD), for example, that is investment grade. But most of that, over 50% of that or 55% of it, is based in financials, mostly banks. So with banks being subject to a lot of scrutiny, you have to watch credit risk.
Then there is high yield, which has been very much sought after, high-yield junk bond sectors, like the High Yield Corporate Bond Fund (HYG). That is really beginning to perk, even though interest rates are very low.
Right now, with the economic data weak, you are going to see people looking more at the high-yield sector, because when economic data is weak the economy is weak. A lot of those high-yield companies or junk-bond companies may not be able to make it.
- Also read: Navigating the Muni Bond Market
Then we see the same thing with emerging-market debt bond ETFs. The same problem there: People are a little bit more worried about the credit quality. So you have to be very selective, and that is why we have a top ten list for corporate bonds and things like that.
Kate Stalter: It sounds like, overall, just caution is really the word at the moment.
Dave Fry: I think that is very true. Even day traders are having a hard time with this market.
Let’s say swing traders, who might hold the position for two or three days. Those are so difficult, because we have seen one day up 100 or up 200, and then the next day you are down a couple of hundred.
So you have had these day-to-day swings in price that you just have to stay away from, unless you are running an HFT, or high-frequency trading operation, where intraday you can probably make some money. But away from that, I don’t see anything right now to stimulate me in either direction.
Even the short side on the ETF area has been very difficult to position, because you have these big countertrend rallies which makes establishing a risk point very difficult.
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