ETF Expert

S&P 500 Spider (SPY): The Myth of a Decline in Corporate Earnings

The media are quick to point out the year-over-year decline in company profits. For the largest 500 companies in the U.S., the collective drop-off is -16.6% on 460 corporate earnings reports.

So why has the S&P 500 SPDR (SPY) still managed to rally 4.0% since earnings season began on April 7, 2008? Perhaps it might have something to do with 7 out of the 9 major economic segments posting gains!

Energy, Materials, Staples and Technology all posted double-digit growth from the year prior. Earnings in the Utilities segment jumped 7%, while Industrials grew roughly 6%. Health Care increased profits by approximately 5%.

So how did the earnings picture for the entire S&P 500 become so bleak? The usual suspects proffered abysmal year-over-year results.

For example, diversified financials didn't just witness slow growth, the sector experienced unprecedented losses. Earnings declined -85%. (And it was much worse for the banks!)

Retailer profits may only have fallen -16% in aggregate, but consumer durables that include things like furniture and appliances witnessed "crazy" weakness (-240%+). In brief, the consumer has not been buying small ticket or big ticket items.

For those that believe that the worst may be over, or for those who wish to bargain hunt in the wreckage, you'd have to look to early business cycle leaders (e.g., financials, consumer discretionary). Historically, the best time acquire shares in these sectors is half-way through a recession. Are we at a mid-point of a recessionary environment yet?

Another way to look at the effect of current profit growth on stock price appreciation is to look at the gains for each sector since earnings season began. Since the close of market on Monday, April 7, 2008:

Energy SPDR (XLE)                10.4%
Technology SPDR (XLK)          9.3%
Materials SPDR (XLB)              6.4%
Consumer Discretion (XLY)     5.4%
Industrials SPDR (XLI)            3.2%
Utilities SPDR (XLU)                2.9%
Consumer Staples (XLP)         1.1%
Financials SPDR (XLF)               0%
Health Care SPDR (XLV)        -1.1%

For those who believe current earnings have an effect on future stock appreciation (depreciation), there are a number of take-homes for the sector results. First, the areas making the most money year-over-year -- Tech, Energy, Materials -- did post the most impressive gains since Q1 results began coming in.

Second, as poorly as consumer discretionary companies did in Q1 2008, bargain hunters are seeing value in the beaten-down arena. Current losses have not hampered the apparent progress of the S&P Consumer Discretionary Fund (XLY).

Third, how can one explain the general lack of interest in health care and consumer staples, in spite of robust earnings growth? The likely answer must rest with an investor belief that the recession will be mild. After all, investors are not flocking to the traditional safe havens of an early stage economic decline.

Finally, while financials may not have gone anywhere, a 0% return is better than should have expected. Based on the unbelievably poor showings for year-over losses, record write-downs and dire warnings for the future, one might be encouraged with the ability of financials to have "held serve." (Learn more about the "Financial Frontier.")

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Single Country ETFs Versus Regional ETFs: Regionals Maintain the Upper Hand

At the end of March, Barclay's launched the iShares Turkey Index Fund (TUR). Presumably, one can invest in this single country's market with greater ease and efficiency than by using an actively managed mutual fund.

It's been a mere 6 weeks and the investment is up 8% out of the gate. Sound like a winner and an undeniably strong selection... right? However, most emerging market investments have gained the same amount since April 1.

Consider the original... the iShares Emerging Market Index Fund (EEM). Although it is clearly too early to be unequivocal in recommending the diversified exposure of EEM over the single country index fund, I've made the case for regional ETFs over single country ETFs in several previous posts.

Single country ETFs tend to be more volatile... both above and below a regional index. What's more, the single-country selections rarely "out-gun" diversified regional indexes over the long haul.

For instance, fans of the MSCI Mexico Index Fund (EWW) have little reason to be disappointed with a 300% cumulative 5-year return from May 15, 2003 to May 14, 2008. Still, the diversified iShares Latin America Fund (ILF) has rocketed towards a 600% showing.

There are certainly examples of when a country fund like the Singapore Fund (EWS) has out-maneuvered regional plays like the iShares Asia Pacific excluding Japan (EPP). Still, it is difficult to know whether a sojourn into Turkey will play out more or less favorably than generalized emerging market participation.

On 5/14/2008, Tim Seymour from the popular CNBC series, Fast Money, discussed Turkey as an emerging market possibility. He considered the Turkey Index Fund (TUR) in terms of deserving a "C" for its macroeconomics, a "B" for its investability and an "A" for valuation. (I have also written extensively about the pros and cons of investing in Turkey.)

The risk-reward relationship continues to favor regional investing over single country selections. We have Vanguard Emerging Markets (VWO), iShares Emerging Markets (EEM) and Claymore's BRIC Fund (EEB). And they work!

The Middle East and Africa Fund (GAF) was an admirable start to Middle Eastern ETF exposure, but it is primarily an investment in Israel and South Africa. Still, there are plenty of regional funds coming such that... I believe... a Middle Eastern ETF would be a better choice than "Turkey by its lonesome."

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Mid-Sized ETFs: Why the Middle Is Creaming Small ETFs and Large ETFs

If all you ever did was watch CNBC, you'd probably hear an enormous deal made about the Dow and the S&P 500. These benchmarks are for the largest companies on the U.S. exchanges... and their poor YTD showing has the bulls battling the bears claw and jagged toenail.

Even those who are "cautiously optimistic" about a 2nd half bull run for stocks are keeping the "mute button" on their enthusiasm. After all, both the Dow Jones Industrials Trust (DIA) and the S&P 500 SPDR (SPY) are still down year-to-date. And both have yet to convincingly rise above long-term 200-day trendlines.

(Note: The chart below illustrates the Dow's effort to get above its 200-day. SPY's comparative performance is shown, but its 200-day is not.)

Persistent concerns about an economic recovery have kept many away from small-caps. Consider the premier indicator of small-cap well-being, the Russell 2000. The iShares Russell 2000 Fund (IWM) is noticeably negative in 2008. IWM is also struggling to get above its long-term moving average.

And yet, a paradox has emerged. If small is risky, and if large hasn't been much better, can anyone explain the confidence being shown in the mid-cap arena?

I first noticed the "momentum" victory for the iShares S&P 400 Mid Cap Growth (IJK) in February. At that time, I was looking for the best performers off of the January lows. Of course, extreme levels of fear returned in March, and that fear decimated every category. (See "Mid-Cap Growth Has Been Super-Resilient.")

I noticed the "momentum" issue repeat the same pattern in April, as iShares S&P 400 Mid Cap Growth (IJK) was the top size/style performer of the 9 groupings. With "cautious optimism," one could say that mid-cap growth was charting a new uptrend.

While growth has out-hustled value in the mid-cap space, It's important to recognize that mid-sized companies are beating the competition clear across the board. We can see that all of the major mid-cap indicators are actually positive in the year 2008. And they are all above long-term trendlines.

In contrast, we simply can't say the same things for large or small. All categories of small-caps (i.e., growth, blend, value) and all categories of large-caps are still trying to break on through to the up side.

So why have investors embraced the middle path? A variety of forces may be at play.

First, there are those who may be betting on an economic recovery. Small- and mid-sized companies historically thrive in recovery periods and growing companies tend to receive premiums. Yet a "slow-to-fully-take-effect" recovery hinders a smallest company revival. Meanwhile, mid-sized companies are more established then their smaller brethren, and they will likely make the eventual leap to large, even in a slow growth environment.

Second, the long-term investor may be intrigued by the 5-year outperformance of mid-cap investing. Or as Trang Ho for Investor's Business Daily puts it, "mid-caps represent the market's sweet spot."

Finally, normal rotation may be occurring; that is, investors were getting the most bang for their buck in small caps from 2003-2005. Form the 2nd half of 2006 through 2007, the largest companies seemed to be getting capital inflow in a later stage economic cycle. It follows that we may be seeing a rotation into a perceived recovery play that is safer than small, yet craftier than "going large."

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

The "3 Rs" in ETFs: Resources, REITs and Retail

The world's running out of everything: food, clean water, fossil fuels, metals. You name the resource and you're likely to hear that there's very little to go around.

Step back in time a mere 3 years, and there was a similar argument for real estate. Too many people. Too few places to build. Real estate prices will continue to skyrocket.

Step back to the year 2000, and dot-com bulls were equally myopic. Too many baby boomers are investing for their future retirement. Too few shares of companies are available. Stock prices will soar to Dow 40,000 by 2008.

Am I suggesting that the darlings of the ETF arena, "Resources ETFs," will tank? Not at all. Yet it's important to recognize the psychology of fear and greed.

Booms go bust... in every asset class, in every business cycle. It follows that investors must have a plan to sell. (Understanding the wisdom of avoiding the big loss is critical to long-term success.)

The prevailing winds on Resources ETFs would suggest that the boom shall continue. One can invest in natural resources companies through the iShares Natural Resources (IGE) fund, though nearly 70% of the sector weighting is in energy companies. If you prefer more iron, steel and silver, companies that extract minerals and metals can be had in the S&P Metals and Mining Fund (XME).

Where's the water? The Powershares Water Resources Fund (PHO) is a high-volume investment in water services companies. It is more of an infrastructure demand play than a direct investment in the commodity. One can diversify across the commodity landscape of oil, wheat, livestock, natural gas, gold, silver, steel and so forth with the Dow Jones Commodity Index (DJP). (See why I prefer a total commodity approach to a single commodity approach here.)

While Resources ETFs are currently booming in a very big way, what should we make of areas that have already gone bust? The consumer spending slowdown has crippled retailers. And the financial credit crisis made real estate investing trusts one of the least desirable areas in 2007.

Ahhhh... but some investors are out bargain hunting. The Vanguard REIT Index (VNQ) is above its long-term trendline and has outperformed the broader stock market in 2008. Ditto for the Retail HOLDRs (RTH).

That's right. Some of the worst investments in 2007 are outperforming in 2008.

The take-away? Recognize that there may be beaten-down value in the unloved areas of a stagnant economy. What's more, as powerful and as energetic as Resources ETFs have been, the possibility of "irrational commodity exuberance" requires your attention.

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.

Currency ETFs: The Euro Is "Soooo" Yesterday

I wrote extensively about investing in the Euro last year. In September 2007, I considered the CurrencyShares Euro (FXE) the "closest thing to a sure thing."

Yet smarter investors are not going to bet in favor of the euro and against the U.S. dollar for much longer. Consider the facts:

1. The U.S. economy is experiencing recessionary pressures from "real estate gone wild." Still, we're not headed for the bread lines. And the treasury yield curve is signaling that the U.S. will recover down the road. (See my previous column, "Wanna Know When Things Will Get Better?")

2. The U.S. Federal Reserve is going to hold rates steady for the foreseeable future. Meanwhile, there's already evidence of slower growth in Europe. In fact, some economists see eurozone growth slowing to the point where the European Central Bank will have to cut interest rates. While the differing directions in monetary policies won't send the U.S. dollar soaring, the circumstances do not indicate further deterioration for the U.S. currency.

3. Investors typically move in droves to gold when they worry about the safety of the U.S. dollar. Yet, gold peaked in the third week of March as the Fed was busy orchestrating JP Morgan's acquisition of Bear Stearns. Similarly, The U.S. dollar more or less hit rock bottom during "March Madness." (See the price movement of Gold (GLD) and the PowerShares DB US Dollar Index Bullish (UUP) in the chart below.)

The "contrarian" indicators couldn't be more favorable for the U.S. dollar; that is, there have been endless stories on the death of the U.S. currency, beginning with the Economist's December 1, 2007 cover. There, one sees George Washington's face on the $1 bill of an airplane going down in flames. Similar stories on the death of the U.S. currency have appeared with increasing frequency throughout 2008.

It follows that it makes little sense to favor the euro over the U.S. currency. The CurrencyShares Euro (FXE) is yesterday's news.

Am I bullish on the U.S. dollar? Not exactly. Our stagflation-prone/super slow-growth economy isn't a prescription for steady appreciation in the buck.

Instead, I have suggested that the next "sure thing" may be the Chinese renminbi (yuan). Other emerging market currencies may gain ground as well.

How can you successfully invest in these currencies? Starting tomorrow, May 13, the launch of 3 new ETFs by WisdomTree will give investors the opportunity to invest in the Chinese Yuan (CYB), the Indian Rupee (ICN) and/or the Brazilian Real (BZF).

Before diving in, it would be nice to see a pattern of trading for these new currency ETFs. If you're looking to invest immediately in Asian currency strength, you may wish to consider the Merk Asian Currency Fund (MEAFX).   

Disclosure Statement: ETF Expert is a web log ("blog") that makes the world of ETFs easier to understand. Pacific Park Financial, Inc., a Registered Investment Advisor with the SEC, may hold positions in the ETFs, mutual funds and/or index funds mentioned above. Investors who are interested in money management services may visit the Pacific Park Financial, Inc. web site.