ETF Update: A Contrarian Call on Chip Stocks

Over the last two weeks of trading, those focused on the daily lesson have come to expect that stocks will move lower.  We all know about behavioral finance.  We know how easily humans see a "pattern" from a few data points.

Here is the interesting thing about patterns:

There is no "flu shot" for behavioral finance.

If you give traders a few days of trading experience — higher open, selling, lower close — they will all learn the drill.  The long-awaited "correction" is upon us.  The model is more cautious, but does not agree with the knee-jerk reaction.  There are still many attractive sectors.

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.  Beginning last week, I introduced a
separate look ahead with our model output as part of the message. 
Regular readers can look here for that content.  I will no longer do a macro
look in this weekly ETF post.

Checking Out the Chips

We trade semiconductor stocks via the HOLDRS (SMH).    Weighting by market cap means that Intel (INTC), Texas Instruments (TXN), and Applied Materials (AMAT) make up 55% of the fund.  The P/E is 25.5.  That is an attractive valuation if you expect further improvement in the cycle, but expensive if you are an economic skeptic.

Here is the daily chart.

You can readily see the January selling, much steeper than the market.  The weekly chart looks a bit different.

You can still see the recent selling, but also the possibility of support.

The model finds the risk/reward to be attractive — one of the better choices in our ratings.

Other ETF Experts

Each week I consider whether
other ETF experts have also highlighted a sector of interest.  No one really shares our opinion about chip stocks, but there are some interesting comments.

Barron's thinks that the sector has broken through technical support.

Technician Mike Paulenoff agrees, writing as follows:

The SMH, on the
other
hand, had a major reversal in January. Not only did it close well
lower on
the month (opening at 28.35 and closing at 24.76 near the low), it
reversed
from a new high it had made, at 28.72, for the entire upmove from
November
2008.

In addition, the trendline from the Mar 2009 low through the Jan 2010
high
was broken at about 25.85-25.90. In addition, the 36-month moving
average also
was an impediment to upside continuation, retaining the moving in
December
and again in January, and in the future will be a serious resistance
plateau
for the semiconductors.

With a Jan close at 24.76, the next level is around 24 1/2 down to
23.00,
with Nov & Oct provide support in the 24.10 to 23.00 area, where
the 12-month
moving average is rising. My sense is the semis have reversed trend
completely,
which is to say the entire up-channel ahs been broken and reversed,
and we're
going to retrace most of it, especially if lower support in the 20.00
is broken.

See SMH video analysis at http://www.mptrader.com/chartsofweek/8/

Only the Trading Goddess considers buying SMH and only as a hedge against shorts.

We shall see.

Weekly TCA-ETF Rankings

It was another tough week for those long the market.  The S&P 500 dropped over 1.6%, but it felt worse because of the daily pattern.  Up opening, lower close.  Our frequent trading program actually was positive on the week, but the weekly method lost ground.

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.