As Fear Rises, Risk Avoidance Wins

09/29/2008 12:00 am EST

Focus: ETFS

Jim Farrish

Founder and CIO, Jim's Notes

Investor sentiment remains negative amid the challenges facing the market. The imminent passage of the Treasury’s $700-billion financial rescue plan was trumped by foreign banking problems and a weak economic picture at home. While lawmakers iron out the final details of the bailout package, investors weigh the risk of being invested in stocks.

Fear is rising, putting downward pressure on the broad markets. After steep declines in Asia and Europe, US markets opened sharply lower Monday, with the Dow Jones Industrial Average off nearly 300 points.

The financial sector remains the topic of choice. Investors try to convince themselves it’s OK to buy these stocks, because the values they see are worth the risk. Not to be a pessimist, but I heard similar rationales in 2002 as the technology sector looked for a bottom from the dot.com bubble.

My focus remains on the SPDR KBW Banking Index ETF (Amex: KBE), as a barometer.  The short-term up trend is still in play, with resistance near $37 and support at the 50-day moving average ($33.40). (It traded near there Monday morning—Editor.) This week could determine the short-term direction of this ETF—up or down?

The Standard & Poor’s 500 index lost 3.2% last week, while the financial sector declined nearly 5% on the week as lawmakers haggled over the contents of a rescue plan. On Sunday night the agreement of a plan was announced, and it will go to Congress on Monday to debate and vote. That will prompt more grandstanding by legislators and the eventual approval of the largest government intervention since the 1929 crash. Not a big confidence builder for investors.

Last week’s biggest decline came from the basic materials sector SPDR Basic Materials Index ETF (Amex: XLB), down 8.3%. Friday’s close found support at the March 2007 low. The sector has declined 31.4% from the June high. The selloff in commodities is putting pressure on the sector. We could find support short term at this level, as other technical data indicate the sector is oversold and could lead to a bounce.

SPDR Energy Index ETF (Amex: XLE) and SPDR Industrials Index ETF (Amex:XLI) joined the down side, each losing 4.5% on the week. This is adding to the down side pressure as investors abandon the previous leaders.

Consumer staples showed a gain of 1% and continued to be the choice for leadership near term. This is where defensive money is heading with the economic outlook on the down side. The SPDR Consumer Staples Index (ETF XLP) is the best way to play the sector. It was off only slightly in Monday morning’s trading.

Since January, I have been telling investors to overweight their portfolios to cash. The risk of this market has continued to increase. The bailout may be a start to changing the trend, but I would let the trend change prior to committing money.

So far this year, the best performing sector is consumer staples, which is down 3%. Money market returns are up 2%. The difference isn’t the 5% per se; it is the risk premium and peace of mind. Other sectors have fared much worse—financials are down 26.5%; technology is off 22%; utilities have lost 18%, and the S&P 500 index has declined 17.2%.

Sometimes risk avoidance is a better investment.

Jim Farrish, founder and editor of Melbourne, Florida-based SectorExchange.com, writes regularly about sectors and speaks widely about investing and money management.

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