ETF Update: The Search for Oil

Are there any bright spots in this market?

In normal times investors can use sector investing to find opportunities despite overall market weakness.  The last two years have provided fewer such opportunities.  The correlation among sectors has been very high in both directions.  Most recently, sector strength has been linked to dollar weakness.

An energy play seems counter-intuitive, but our model rates it as the top choice this week.

Background

Each week we provide a list of sectors emphasizing those that we expect to have the best performance over the next three weeks.  ETF investors can check out the list and compare our findings with their own conclusions.

In our analysis, we consider Trends, Cycles, and a bit of Anticipation.  While our ratings share characteristics with momentum and relative strength approaches, there are important differences.  Since we apply the model to nearly 300 ETF's, we call it the TCA-ETF system.  (For new readers, there is a more complete description of our methods at the end of the article.  We also have a free report with more detail on the system and results, available on request.)

The model also provides a nice feel for the overall potential of the market.  It is not the forest nor the individual trees, but something in between.  I have been using this as part of the basis for "macro commentary" on the market.

Regular readers know that we also use the system for a macro look at the market.  I am now doing that as a separate piece found here.

Exploring for Oil

We trade the quest for energy via the SPDR S&P Oil & Gas Exploration & Production ETF (XOP).  The holdings include over thirty names with roughly equal weights for each.  The fund has a P/E of about 20 and an earnings growth rate of 12%, but this does not tell the whole story.  Long-term investors in this sector are more interested in assets and cash flows -- always important, but even more so in high cap-ex areas.  The model, of course is driven by technical information.  Here is the chart:

That chart shows two years, illustrating the 2008 highs.  Let's look at just one year.

We have had this position for two weeks, and not very successfully.  It does seem to have some near-term support.  We own XOP, but it is easy to see some risk.

Other ETF Experts

Each week I consider what other ETF experts have to say about our featured sector.

Tom Lydon sees the key to future growth as the acquisition strategy for the group.

ETF Daily News stopped out several positions last week (as did we) and XOP was one of them.

Gary Gordon summarizes performance for the month and shows XOP as the best of a bad lot.

As I said at the top, it is difficult to find a good sector in this market.  The trading situation is very fluid, and our positions could change rapidly.

Weekly TCA-ETF Rankings

It was another losing week for those long the market.  The S&P 500 dropped less than 1%, but it felt worse because of the volatility and the big loss on Thursday.  Our frequent trading program lost a bit more than the market this week, but actually has a gain of about 3.5% over the last two weeks.  Once again, it was difficult to match this in the weekly program.

We'll try to highlight some of the difference in a future article.  Briefly put, we run the model twice each day.  For the frequent trading program (ultra-low commissions) we make daily adjustments.  For the weekly program we take a look every day, but do a full synchronization only once a week.  If there is a dramatic change we might act more frequently, but it is a balance between trading costs and finding the optimal position.

We are reporting our NewArc 55, a list of ETF's that has little overlap and low trading costs.  We continue to rate all sectors, a report that is available upon request.  Here is the weekly report, based upon last Thursday's close.

Note for New Readers

Our weekly ETF Update is designed to assist both investors and traders interested in ETF's and Sector Rotation.  Before turning to the current rankings, let us undertake a review for readers new to this series.

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.

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