ETF Update: The Surprising Strength of Health Care

ETFs provide a great trading vehicle.  One of our programs uses a 28-member universe to find the most promising sector for the next three weeks.

I have not provided the ETF updates during the last year, but some readers have subscribed to weekly updates with briefly delayed ratings (available via email to etf at newarc dot com).

The ratings are not just a recommendation of what to buy right now, although that is a very profitable approach.  I use the ratings for three distinct purposes:

  1. Overall market strength, reported in my weekly WTWA articles
  2. Finding the best sectors
  3. Using the top sector choices as a starting point to find individual stocks.

Our popular trading model, "Felix", provides the ratings.  With this background in mind, let us take a peek at the most recent output.  The advice of Felix is something that I had mind when I wrote about the difference between wise traders and wise investors.

Time to buy health care?

This week’s featured ETF is the Health Care SPDR (XLV). This is one-stop shopping for all of the big name health care stocks.  The top holdings include JNJ, PFE and MRK, which make up 32% of the fund.  The top ten constitute 58%, so the overall concentration is not too bad.

The trailing P/E ratio for the fund is 14 — pretty attractive.  The dividend yield is 1.92%

These are metrics for investors.  Traders, including Felix (our model) are more interested in the tale of the tape.  Take a look at the chart:


Felix does not explain reasons, but I know from experience that a chart with apparent support, a recent high, and a modest pull back usually earns a “buy” rating.   These features leap out.

Fundamental Rationale

I usually like to cite other ETF experts on what is happening with the sector, but there is not much recent commentary.  From my own analysis I know that health care stocks are part of a strong growth sector, but there is a cloud because of the uncertainty surrounding ObamaCare.

Eventually, these will be good holdings — especially insurance stocks (UNH, WLP) which we hold for some accounts and devices (RMD, SYK) which we also favor.  This week there was pressure on some stocks since Ohio is playing hardball on who is authorized for Medicaid.

Model Output

The results of the model as of 04/11/12 are below. For those in this trading program we decreased to only one position. This report shows ratings from our balanced universe — designed so that we do not get too many highly similar sectors in the top three.

Please keep in mind that this is a holding for an active trading program. The model rates this as the best choice for the next three weeks, but this is a question we ask every day! Felix may come up with even better choices, and we will adjust our trading accordingly.

The ratings have two parts — the strength and the penalty box. The strength rating shows how we expect the sector to perform over the next three weeks compared to the historical norm. A rating of 100 is one standard deviation better than average. The penalty box represents our confidence in the forecast. Many astute traders just step away from a confusing market. Felix does the same thing. When we have little confidence in our ratings, the sector goes into the Penalty Box. For some additional information, here is the article where I introduced the system to WSAS readers.

We have NOT been fully invested this week. The top-rated and only ETF out of the penalty box is: Health Care SPDR (XLV). Our median strength has gone negative to -14. There are only 25% of the ETFs that have a positive strength, and some of these are inverse funds. The number of ETFs in the penalty box has soared to 96%. While the model likes health care, the overall message is bearish.

Felix does not anticipate tops and bottoms.  Felix has kept us profitably in the market since mid-December.  There are now some signs to step back a bit.  While the rally may continue, we can afford to miss a few days after such a long run.

Here are the ratings:


 [long XLV, SYK, RMD, UNH, WLP in individual and institutional accounts.]

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  • Proteus April 13, 2012  

    Jeff, apologies if you covered this before, but how did you choose the specific ETFs listed above? There doesn’t seem to be a pattern. Liquidity is one factor, I guess, but are correlations considered, or do they just work well with the model?

  • oldprof April 13, 2012  

    Proteus — We did choose the specific list, but we also monitor a much larger list that includes nearly everything. Usually the top candidates there correspond to the trading universe. If there is something different and intriguing, we take a look.
    The current list represents diversity and liquidity, and avoids duplication. If, for example, Latin America is strong, I do not want the top three holdings to be different Latin American countries. We are investing in the top three, so I want a single candidate for each theme. If someone prefers Venezuela to Chile, they can look at the longer list to choose.
    Meanwhile — suggestions are most welcome!

  • Proteus April 14, 2012  

    OK, thanks, makes sense.
    There are some bond funds that I didn’t see represented – TIPS, high yield, EM, and international, although I’m not sure these add a lot of diversity.
    I might have broken up the European fund into two smaller funds, but I can’t for the life of me figure out a good combination of two. Scandinavia, UK, north/central Europe, southern Europe, eastern Europe, and Israel plus some frontier Africa. Now I’m open to suggestions 🙂

  • Houston Botox April 20, 2012  

    I would not shed too many tears for the health insurance industry. They really are not needed.
    The main function of the health insurance industry is to engage in medical underwriting — that is, excluding those with pre-existing conditions from getting health insurance, and by extension, health care. The role of the health insurance industry is to insure that sick people die.
    We really don’t need them. The whole point of the ACA is to eliminate medical underwriting. Once medical underwriting ceases to exist, the whole health insurance industry serves no purpose but to collect rents.