ETF Update: Hidden Correlations in Sector Choices

Here at "A Dash" we analyze many different investment approaches.  In our financial management we follow two basic methods:

  • A fundamental value analysis.  We are normally fully invested, but can back off a bit in certain circumstances.  We have a method for finding edge, based upon our own set of key indicators, and call it our Great Stocks program.  For shorthand, we call it the "Jeff model."
  • A sophisticated computer model that analyzes a universe of ETF's looking for emerging Trends, Cyclical behavior, and including a touch of Anticipation.  We call this the TCA-ETF approach, and call it the "Vince model" after its creator.  (The complete current rankings are at the end of the article, along with an explanation of our methodology).

The Vince model has had a nice run, but Jeff is still ahead on the year.  It is a friendly competition.

How to Learn from Models

When we do our analysis on the fundamentals, we always pay attention to the TCA-ETF results.  You can do the same.  The way to do this is to make your own decisions, but then to check the ratings to see what the "expert system" analysis tells you.  This is mostly technical, an indication of what is likely to work — the market verdict, so to speak.

Let us take a look at this week's ratings for an important lesson in using this information.

Hidden Correlations

This week's ratings, listed in full at the end of the article, include energy holdings, alternative energy, and foreign country ETF's.  At first glance, it seems like this is a diverse portfolio.

In fact, there is a common theme.  During the last week there was a major concern about the rating for sovereign debt and also the value of the dollar.  If one thinks about this, the sectors are all keyed to the dollar.  Commodities are dollar-denominated, and foreign ETF's link both to the dollar and commodities.

Briefly put, your apparently diversified portfolio is actually highly-correlated to dollar weakness.

Commentary on Dollar Weakness

There were several perceptive commentaries on the dollar and the effects.

The best analysis was from Dr. Brett (one of our featured sites), who wrote on May 20th as follows:

With low interest rates and rising national debt, the dollar is not as attractive as a currency, with several countries expressing interest in further diversifying their reserves. With the Fed contemplating further "quantitative easing",
the market fears that the dollar printing press will be working
overtime. That is lending support to commodities denominated in dollars.

And again two days later, he emphasized inter-market effects:

Could we be looking at inflation sooner than expected?
If so, that would have important implications for Federal Reserve
policy, interest rates, commodities, and the prospects for sustained
economic recovery.

There was also commentary from mainstream media, but without all of the implications.

Our Take

When we see these hidden correlations we become more cautious and reach for some diversification.  If we have sectors that are rated a bit lower, but not playing for a weak dollar, we include those in our portfolio.  It is important not to follow one's model in a blind fashion when there are reasonable alternatives.

Weekly TCA-ETF Rankings

While 33 of our
57 sectors are in the
"buy" range, the strength is dropping dramatically for most.  The index ETF's are weak, with the Q's in the penalty box.  It is a weak overall picture.

portfolio had a great weak, gaining almost 6% versus 0.5% for the S&P 500.

Based upon the model signals, we shifted our long-standing official bullish
position to neutral in the Ticker Sense Blogger Sentiment poll.  Sorry for the delay in our update, normally done on the weekend.  (Even the old prof takes some time off, on occasion).  Those subscribing to the weekly report get the information in advance via email.


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

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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