As the third quarter came to a close, investors were still enjoying the benefits of a bull market. But behind the scenes of the "Dow 12,000" hype, the reality is that groups of stocks are moving, not the whole market.
This presents an ideal opportunity for ETF investors who can follow trends.
Looking forward to the fourth quarter and 2007, we put together a portfolio of ETFs we like (the long portfolio) and one of those we expect to do poorly (the short portfolio) from a universe of the nearly 200 ETFs we rate.
Be ready for a few surprises.
But first, a caveat: These two portfolios do not aim for uncorrelated returns and are not intended to maximize aggregate unit performance up or down.
Rather than being specific recommendations, these are merely theoretical portfolios to help you make clearer decisions about your own investments. Our fund model calls for a conservative view of additional exposure to most U.S.-only sector-style ETFs.
To qualify for the long portfolio, the selected ETF had to have an overall score in the top 30th percentile.
The overall rating considers total return to shareholders, timeliness and low price volatility -- the three core factors in our ratings model.
We chose investment styles that our fund model says are working on the basis of the number of high ratings in the group and recent performance trends.
Here, then, are the ETFs that fit the long-portfolio profile and meet our investment criteria. On the next page I give you my reasoning for each fund's inclusion in this mock portfolio.
Looking over the picks, some of the themes from our August
Top Five ETFs to Buy Now story remain in place.
- Look abroad for better returns: The long portfolio is weighted 20% in country funds and in emerging markets, with holdings in iShares MSCI Spain (EWP) - Get iShares MSCI Spain ETF Report and Vanguard Emerging-Markets ETF (VWO) - Get Vanguard FTSE Emerging Markets ETF Report.
- The U.S. economy is still strong: Two ETF groups that ranked well in our model were late-cycle sectors such as utilities and financial services, up 16.8% and 13.8% year to date, respectively, on the basis of U.S. SPDR benchmarks for those two sectors. For the utilities group, the highest rating goes to Utilities HOLDRs (UTH) . But for the financials, more value may be had with the global versions that carry higher ratings and less U.S. interest-rate risk, such as the iShares S&P Global Financials (IXG) - Get iShares Global Financials ETF Report.
- Stick with energy: Admittedly, our model also gave energy funds good marks, but the price swings of energy stocks and energy-related ETFs have been disheartening, despite a nice recovery lately. Our new energy ETF favorite is iShares Dow Jones U.S. Energy (IYE) - Get iShares U.S. Energy ETF Report.
- Go for the gold: Precious-metals ETFs should be a standard part of the portfolio. See our recent article on streetTracks Gold Shares (GLD) - Get SPDR Gold Shares Report.
- Global is better in telecom: Our pick for telecommunications is the S&P Global Telecom Fund (IXP) - Get iShares Global Comm Services ETF Report, which has outperformed its domestic-only counterpart, the Dow Jones U.S. Telecommunications Sector Index Fund (IYZ) - Get iShares U.S. Telecommunications ETF Report.
There is one new theme: Get income. Three of the 10 ETFs highlighted can be characterized as pro-income.
- The iShares Russell Mid-Cap Value (IWS) - Get iShares Russell Mid-Cap Value ETF Report returns as a top pick. The idea with this type of fund is to find stocks that are undervalued with lower price-to-book ratios. In times of slowing overall growth, these become relatively more attractive.
- A new pick is the iShares Morningstar Large Value (JKF) - Get iShares Morningstar Value ETF Report. Stocks that pay dividends are less likely to fall below yield-based support levels. This fund also reinforces the financial services, utilities and energy plays, with two-thirds of the fund in these sectors.
- Despite all the talk of a tumbling property market, real estate investment trusts, or REITs, are leading our growth and income category of ETF ratings. The Vanguard REIT Vipers (VNQ) - Get Vanguard Real Estate ETF Report, with a 12-basis-point expense ratio, is the cleanest way to add exposure to real estate to your stock portfolio.
The strong ratings for REITs, equity-income funds and large-cap value funds in our long ETF portfolio point to a greater focus on dividends and stable returns for 2007. This is certainly a more defensive portfolio.
Assuming more economic weakness next year, where are the opportunities to short the market?
Click this link to see my ideas.
Rudy Martin is the director of research for TheStreet.com Ratings. In keeping with TSC?s Investment Policy, employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.
In keeping with TSC?s Investment Policy, employees of TheStreet.com Ratings with access to pre-publication ratings data must pre-clear any potential trade through the legal department, and are prohibited from trading any security that is the subject of an unpublished rating revision until the second business day after the rating is published.
While Martin cannot provide investment advice or recommendations, he appreciates your feedback;
to send him an email.