Sector ETF Backtesting -- Tips & Tricks

Oct 30, 2018 in Sectors | Video

A video to address US Sector Backtesting -- straight relative strength is not often the best way to go with regard to sectors. The public video below uses the following subscriber-only backtest ETFreplay Advanced Relative Strength Backtest

 

 to expand video on screen, click the '4 expanding arrows' icon in the bottom right corner of the video screen

 

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Low Volatility vs Consumer Staples Sector ETF USMV vs XLP

May 20, 2016 in Sectors | Volatility

Attached is the longer-term performance of Low Volatility (using the index that USMV tracks for its Total Return) vs Consumer Staples (using XLP, the consumer staples SPDR).

These 2 are both low vol equities but as you can see -- are not exactly the same thing.

 

 

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Financials Sector Earnings Per Share

Jul 01, 2014 in Earnings | Sectors

A look at Financial Sector Earnings. 

 

 

 

 

Understand the ETFreplay Backtesting Layout Here:

ETFreplay Backtesting Layout Video

 

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When Rates Go Up, Which Sectors Do Relatively Better

May 31, 2013 in Bonds | Sectors

1202 days in past 10 years that TLT went down.

 

 

Now applying the 10-Year Data to Current Situation --  May 2013 (1 day prior to end of month):

 

 

 

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Technology Sector ETF Briefing

Feb 08, 2013 in Earnings | Sectors

Technology was ground zero of the 2001 recession.   It also took a big hit in 2008 but it was housing & financials that were the central problems in 2008.    In 2013, at first blush Tech once again has an ominous feeling to it:

 

 

Tech is 20.8% of S&P 500 estimated EPS and the largest component -- so this is obviously important.   Here is the present breakdown of the current ~$111.00 S&P 500 estimate:

 

And here are the largest market cap companies within the tech sector:

This situation is not much like 2001-2002, many components of tech are doing quite well (QCOM, ORCL, V etc..).   Apple took a big hit in earnings but its hard to imagine a scenario where it melts down from here like Cisco and others did back in 2001.   Cisco rode the telecom bubble up and then crashed.   Apples customer base isn't in crash mode so from that perspective it is not at all comparable.   Companies like Microsoft & IBM are very large net income contributors and have stable businesses and in no way can you say they have benefit from any type of telecom/internet bubble in recent years.

As we scan this list, it is remarkable how balanced it seems.  Indeed, a company like Hewlett-Packard is only 3.0% of the technology SECTOR net income and far less than that in terms of overall S&P 500 earnings.   But that doesn't mean something unforseen can't develop which sinks a lot of these companies earnings -- and we should continue to monitor where problems develop and how likely that could be to cause problems in overall economy.  

Note that if you look at a equal-weighted version of Tech (RYT),  rather than an AAPL weighted version -- it is a much different look.

 

 

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Financials vs Technology Sector Earnings

Jan 20, 2013 in Earnings | Sectors

In the last blog post, we showed how S&P 500 earnings were tracking vs past years.  This blog looks at 2 of the major sectors that generate those earnings.

All of the major banks have reported earnings for Q4 and given guidance for 2013, so estimates for those companies are up to date.   Meanwhile, tech companies for the most part will be reporting over the next 2 weeks.   Nevertheless, in the chart below you can see how tech is pulling the overall S&P 500 earnings down while Financials have been a positive influence since Sep 30.

 

Below is a comparison of the recent returns for these 2 key sectors:

 

 

 

Since many XLF components have reported earnings recently, here is a look at the components:

 

 

Note how Goldman Sachs is the leader here.   The largest negative contributor to S&P earnings has been Apple -- having missed the September quarter and analysts have continued to cut estimates since.   Below compares GS to AAPL for a striking difference:

 

Feedback is welcome -- please let us know if you like this kind of detail on key ETF holdings or if you have any comments or questions: Contact Us

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Sector ETF Investing: Black Diamond, Beware

Jul 30, 2012 in Sectors

 

At ski resorts in the U.S. each ski run is denoted with a symbol.  A green circle is for 'Easiest' runs, a Blue Square is for 'Moderate' and the more difficult runs are marked with a 'Black Diamond'.  A Double black diamond would be for experts only.   Perhaps ETFs should adopt this system?  

 

The most volatile are black diamonds and any short-duration bond funds would be marked Green.   Of course, there is no enjoyment in going 'down' green runs, you spend all your time and effort just planning how you are going to maintain some speed so that you don't come to a complete stop. 

 

If you look at virtually any institutional money managers quarterly or semi-annual review,  there is usually something that has a few lines similar to this:  'we are overweight energy for reason X [and insert reason why] and underweight financials for reason Y [and insert reason why]' etc...   Then there is usually a data table comparing the fund to its benchmark across each sector.

 

Let's take a look at some recent trends in Sector ETF investing.  For this, we pair up 2 sectors:  [Financials + Energy] vs [Staples + Utilities].    We link these together because these are classic 'High-Beta' vs 'Low-Vol' types of analysis (in recent years the popular terminology has been: 'risk-on' / 'risk-off') -- but it's all the same idea.   

 

Below is the second half of 2011.  

 

Put yourself in the spot of a fund manager trying to explain their sector positioning at each point in time.   Note that Staples + Utilities had a sharp but very short-lived corrective move beginning in July, 2011 and then promptly retraced the entire amount back up in September and then actually went back above the July/Aug highs soon thereafter.  Meanwhile, Financials and Energy continued to correct hard into very beginning of October and then go into a vertical short-squeeze type of move up that lasts about a month and then entering a volatile trading range through the end of the year.

By the time the year ends, many managers not watching such things in this format are wondering how in the world the S&P 500 ended up +2.0% (total return) for the year.    Hedge funds got whipped around badly as this action is indeed very tricky if you are spending your time trying to figure out how it all makes sense fundamentally.  But the fact is that the market doesn't sit around and wait for you to figure out how it all makes sense before it does its next thing.    Managers coming up with reasons for their quarterly positioning often have a tough go of figuring out how to make it look like they know what they are talking about.

Ok, so now say you got it right during the second half of 2011 and were overweight low-vol segments (think high dividend stocks).  Great.  Now the first quarter of 2012 begins and the exact opposite occurs.

 

As the new year got underway, the market begins with a large rally in 'high-beta' assets while classic low-vol sectors like Staples & Utilities actually go down.   High-beta had a big first quarter with low-vol lagging.   The manager who was (rightly) defensive in 2011 now has a tough time justifying why they are off to such a rough start to 2012.   Some managers likely then took their high-beta exposure up to reduce the pain.     And what has happened since then?  

 

Naturally, there was another large internal rotation with the overall market going nowhere while low-vol segments outperforming strongly with high-beta trading down.

So that is where we stand now --- these sets of ETFs are now essentially up about the same amount YTD -- but with very different paths to get here.    Given the large outperformance during the second half of 2011, the 12-month chart of course looks quite different --- with low-vol segments like Staples and Utilities back at all-time highs.

A lot of members who begin at ETFreplay set up a 'sector portfolio' --- ie, the Sector SPDRs or Vanguard Sectors.  It might be natural -- that is how a lot of people think about investing -- overweight this sector and underweight that sector.     But once you start backtesting such strategies, you may start to realize --- wow, this doesn't work very well.  

Well, look on the bright side, it's a good thing you tested it before thinking you had something.   Indeed, sector investing can be treacherous and that isn't a new thing.   We have done many examples on this blog and within the demos on the site and we've never done a sector example (it wasn't for a lack of trying various ideas).  The reason is that we just think there is a lot of lower hanging fruit than that.   We don't care to ski double black-diamonds when there are nice blue square runs out there.  

That all said, if you do indeed want to test sector strategies -- then we suggest a particular module called  'Ratio Moving Average backtest' -- our work shows some potential in this area.   However, we would stay away from things like XLE vs SPY.  There are 1400 ETFs after all, it's ok to have some imagination beyond the over-researched and over-analyzed sector approach.

Thinking from a return-risk perspective,  we do have one idea for sectors -- it involves just buying and holding lower-vol sectors and then barbelling that by tactically adjusting higher-beta exposures using the 'Ratio Moving Average' module.   If you do it like that, then you will generally create risk in the end that is similar to the overall market -- and you will greatly reduce getting caught in buying back into high-beta AFTER its had a run.

The 'Ratio MA' module compares 2 ETFs and attaches rules to trade the ratio between two market segments.   We prefer using uncorrelated ETFs in this analysis --- ie,  XLF vs IEF  --- rather than one equity ETF vs another equity ETF.  But we certainly look forward to seeing other possible techniques by watching members ideas develop on the Allocations Board

Summary:  In our opinion, sector ETF timing is something that we think is probably over-researched (and the charts above indicate its 'black-diamond' nature).

Backtesting is inherently evidence-based.   When you learn something in backtesting, then use that knowledge.   Don't try to force-fit a generic sector list into a strategy --  be flexible and don't stop the learning process.  Financial relationships can be dynamic --- that is, they can change in sometimes tricky ways.   If you have trouble making something deliver good reward/risk -- then take heed -- it probably has no edge and is therefore just a random walk.  Like the signs in the picture above --- there are various levels of difficulty.   If you go down the steepest run,  you may 'expect' to get to your destination more quickly -- but that doesn't mean you actually will -- the chance of crashing and burning is the other possible outcome.   The last 20 years are filled with managers who ski'd recklessly and won the short-term race  --- and then eventually ended up in the Ski Patrol sled.

Focus on reward-risk as a relationship.   Not just return and not just risk.

 

 

 

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