ETF Periscope: Stress Tests, Fed Frets and Sideways Bets

Stress Tests, Fed Frets and Sideways Bets

by Daniel Sckolnik of ETF Periscope

"A child of five would understand this. Send someone to fetch a child of five." ~ Groucho Marx

There was something for everybody in the markets this week, with huge servings of earnings releases, multiple throat-clearings from the grizzled gentleman at the Fed, and test results out of Europe that were as subject to interpretation as a large splatter of ink on white paper.

On Wednesday, Federal Reserve Chairman Ben Bernanke recommended to Congress that they should continue to prop up the sputtering economy, coming in strongly on the stimulus side of the "stimulus versus budget deficits" debate that has two distinct camps circling their respective wagons. The markets gave Ben the raspberry, as the Dow Jones Industrial Average promptly lost over 100 points, ending at 10,120.

However, Bernanke's encore appearance on Thursday got rave reviews. He proclaimed to his Congressional audience: "We are ready and we will act if the economy does not continue to improve -- if we don't see the kind of improvements in the labor market that we are hoping for and expecting," The markets jumped from their seats in a standing ovation, as the Dow took back what was given the previous day and then some, ending at 10,322, up 200 points.

Friday morning came along with its own cargo of drama, as investors and traders waited with rapt attention for the results of the "stress test" conducted on Europe"s banks. The failure rate was pretty much considered acceptable and predictable, with 7 out of 91 banks flunking out, five in Spain, and one each in Greece and Germany. The overall consensus seemed to be that the test was not particularly tough. After bouncing around from top to bottom, the Dow ended up over 100 points for the day and over 300 points for the week.

The rash of earnings reports this week was, on the whole, regarded as quite positive. Those exceeding expectations included Apple (AAPL), American Express (AXP), McDonalds (MCD) and to a lesser extent, Microsoft (MFST). On the flipside, Amazon (AMZN) failed to impress, however, and investors responded with a collective stock dump, though it made a decent recovery by the end of Friday. Still, the overall picture that emerged for the week was that at least one aspect of the economy was proceeding apace.

So, are the markets now ready to make a stab at a bull run? Or has it just received yet another bump up back to the mean, as it once more sits at the mid-point of the range traveled over the last four months? It is, as always, a judgment call, with tea leaves that can be read either way.

A point of consideration may be seen in the chart of the S&P 500 Index. End of day Friday found the index at 1,102. It can be considered an important point, as it has served as a clear level of either support or resistance since October, with the role shifting towards it being a 'lid' in recent months. A breakthrough that can push it above its 200-day moving average, something that has occurred only briefly over the last 12-month period, could be regarded as significant.

What the Periscope Sees

ETF Periscope scopes out the high road in an effort to espy the overall marketscape.

Below is a pair of bullish selections that stand out, based on Sabrient's SectorCast-ETF Rankings. In addition, I've picked out two bearish choices, provided to assist in the effort to "hedge off" the inevitable volatility of the markets.

Within the top 5% of the Rankings sits KBE (SPDR KBW Bank ETF), an exchange-traded fund launched by State Street Global Advisors. The fund invests in stocks of companies operating in the Banking Industry, including national money center banks and regional banking institutions. The fund replicates the KBW Bank Index.

Reading the charts, KBE is hard at work testing its 200-day moving average, wrestling with it for the last two months, trying to decide if it prefers it for support or resistance. A good push up could send it right on through both the 200-day and 50-day MA, a place it hasn't been above in well over a year.

A bit deeper in, yet still within the top 10% of the listings, we find XOP (SPDR S&P Oil & Gas Exploration & Production ETF), an exchange-traded fund that invests in stocks of companies operating in the oil and gas exploration & production segment of a U.S. total market composite index. The fund, before expenses, seeks to replicate as closely as possible the performance of the S&P Oil & Gas Exploration & Production Select Industry Index.

XOP ended the week kissing the underside of its 50-day MA. The 200-day MA hovers just above it, however, and could provide new resistance or, conversely, the possibility of serving as a new line of support.

For the short side of the equation, two selections that follow are worth consideration:

Perusing the bottom 15% of the Rankings is XLB (SPDR S&P Materials Select Sector SPDR Fund) that tracks the Material Select Sector Index, which includes companies from the following industries: chemicals; metals & mining; paper & forest products; containers & packaging; and construction materials.

Far down the list at 336 (out of 345 ETFs that comprise the Rankings) is FXG (First Trust Consumer Staples AlphaDEX Fund), an exchange-traded fund launched and managed by First Trust Portfolios L.P. The fund replicates the StrataQuant Consumer Staples Index by investing in stocks of companies listed in that Index in proportion to their weighting in the Index.

I am using both XLB and FXG to handle the possibility of emerging negative trends in the market equation. Toward this end, you might consider acquiring some slightly out-of-the-money put options a few months out, or you might decide to short the ETFs themselves. As always, the amount of downside "insurance" you choose to secure should reflect your portfolio’s overall bias, be it upward or downward.

ETF Periscope

The author does not personally hold any of the stocks or ETFs mentioned in this week’s “What the Periscope Sees.”

The Process

For myself, as always, I look to Sabrient’s SectorCast-ETF Rankings for some effective insight. The Rankings consist of over 340 ETFs (exchange-traded funds) that are ranked and scored via sixteen of Sabrient’s proprietary analytics, that, when taken as a whole, offer a forward-looking take on the markets.

My process in selecting from among the SectorCast-ETF Rankings includes scanning the top 10-15% of the current list, which is updated three times weekly. I’ll limit my choices to one ETF per sector, in an effort to achieve a healthy level of diversification.

Among the analytics that I pay particular attention to is what Sabrient terms “Bull Score” and “Bear Score.”  The Bull Score offers a “technical” measure of how underlying stocks performed on “up days” in the broader market during the last two month’s action. The higher an ETF’s Bull Score, the better it has performed on recent up days in the market. The flipside analytical, Bear Score, indicates the reverse. The higher an ETF’s Bear Score, the better it has performed on recent “down days” in the market.  A high Bear Score implies a “defensive” ETF.

For me, the Bull Score and Bear Score are among the tools that I incorporate into the overall hedging equation. My ultimate goal is to craft a hedged, lower-risk portfolio that protects against the markets inevitable gyrations while continuing to allow for upside potential.

Next, I’ll look at the ETF’s chart, seeking divine inspiration, or, failing that, at least a high level of technical confirmation via support and resistance levels, simple moving averages, etc. Finally, I’ll check to see if the ETF offers options, which I frequently use in place of buying shares in the ETF itself.

In selecting ETFs to cover the short side of my portfolio, I’ll flip the process, scanning the bottom 10-15% of the Rankings and adapting the Bull Score/Bear Score analytic as appropriate.

Disclaimer: This newsletter is published solely for informational purposes and is not to be construed as advice or a recommendation to specific individuals. Individuals should take into account their personal financial circumstances in acting on any rankings or stock selections provided by Sabrient. Sabrient makes no representations that the techniques used in its rankings or selections will result in or guarantee profits in trading. Trading involves risk, including possible loss of principal and other losses, and past performance is no indication of future results.

ETF Periscope