Sometimes, it's hard to argue with well-reasoned logic. The market was due for a pullback after an incredible 10-week “risk rally,” was it not? And when a profit-taking correction runs its course, investors will again look to natural resources, China and Brazil. After all, these investments will benefit the most from a recovering global economy, right?
I hate to admit it, but I agree with mainstream media on this one. I hate to admit it because the crowd often misses the trend. What's more, I make every conceivable effort to avoid group-think.
Nevertheless, I agree with the premise that worldwide stimulus is reinvigorating the global industrial cycle. And, by extension producer countries, energy, materials and commodities will win the lion’s share of investor interest.
I’ve been laying the case out for weeks. Here are several exchange-traded fund investing posts that I’ve written on the basic thesis:
1. May 6, 2009: Riskier Foreign Assets for the Next Market Correction
2. May 4, 2009: The Countries With the Most Stuff to Sell... Win!
3. April 30, 2009: Getting Technical With Energy ETFs
In truth, I get anxious when others agree with me (or when I agree with them). Yet I draw comfort from the fact that it’s important to have more than a “Buy List.” For one thing, if the widely expected correction starts to turn uglier, I use sell stop orders to protect principal. ETFs are not meant for buying-n-holding-n-hoping that things can only get better.
In addition to maintaining a sell strategy to reduce risk with your ETF portfolio, you need to have genuine diversification. The iShares China 25 Index (FXI), the iShares Brazil Fund (EWZ), the iShares Global Materials Fund (MXI) – these are exceptionally worthy investments. Yet they are all large-company in scope. What’s more, Brazil’s EWZ is nearly identical in price movement to Global Materials (MXI).
One solution is to consider different sectors or different company sizes. For instance, the China Real Estate Fund (TAO) is up twice as much as its older brother, FXI, while providing unique access to growth in China housing.
Similarly, the Brazil Small Cap Fund (BRF) has a 40% weighting in smaller companies that sell food products, household durables and specialty retail items. That’s a fairly significant allocation to the increasing purchasing power of the Brazilian consumer… not merely an energy/materials play.
Smart diversification also requires non-correlating assets in your portfolio. So you can’t simply invest in stock ETFs. If you accept the “reflation” concept, and you probably should, you may want a commodity ETF.
Commodities tend to move independently from stocks over time. In the near-term, the Powershares DB Base Metals Fund (DBB) has risen 25% in 2009, suggesting a resurgence in demand for aluminum, zinc and copper.
Yet the best example of non-correlating diversification of assets exists in the bond ETF arena. In fact, many studies have shown a small negative correlation between international bonds and major stock indexes in the Americas.
Consider the SPDR DB International Government Inflation-Protected Bond Fund (WIP). This fund corresponds to an inflation-linked basket of government bonds outside the U.S. The current yield may be an unimpressive 3%, though the 12-month annual yield is closer to 6%.
For those expecting inflation to pick up, then, an anticipated 6% annual yield distributed monthly may be desirable. Moreover, the average credit quality is a solid Aa3.
The SPDR DB International Government Inflation-Protected Bond Fund (WIP) has also shown the ability to appreciate in price. In fact, WIP has really never looked back in the last 12 weeks. It's gained a healthy 12% and it has recently entered a technical uptrend above a 200-day week moving average.
If you'd like to learn more about ETF investing... then tune into In the Money With Gary Gordon. You can listen to the show live or via podcast or on your iPod.
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 Adviser 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.