Market Signals with ETFs

On June 25th I will have the privilege of conducting a webcast series event for the Market Technicians Association (see upcoming events to your left) on an aspect of ETFs that gets far too little recognition – market signals with ETFs. The webcast will describe how EVERY investor is now empowered to monitor market activity via ETFs and effect an investment strategy that works. The following is an example of how to do this using three major market ETFs:

* For the US, the S&P 500 ETF tracker - SPY
* For Europe, Australia, and the Far East – EFA
* For Emerging Markets – EEM

The power rests in a comparative performance analysis that an investor can employ by delving into those indicators one chooses. As readers of this blog and my newsletter know, in the technical analysis aspect of my work I emphasize divergences and momentum analyses over chart patterns. Therefore, the accompanying charts* help to identify areas of strength or weakness beyond the surface action of each market index. For example, note how the flight to quality in equities produced the above average relative strength while the most recent months show that trend shifting in favor of emerging markets.

Other comparative points worth noting are the never ending high correlations between and among the indices in nearly all aspects of their internals. However, while momentum, MACD, and Show Stochastics all move in unison, at key points divergences could arise. This was the case in early March when Momentum and MACD for EEM was clearly stronger than that for SPY and EFA. As a result, a 1,000 basis point better performance since that time occurred. This should be monitored for future divergences when they occur as they signal a more defined shift in capital allocation among investors.

Investment Strategy Implications

Market signals using ETFs can also be done via size and styles, as well as in other combinations such as country to country. For example, large, mid, small, and even micro cap can be compared and contrasted (to use CFA® terminology) to enable an investor to identify trend changes as well as measuring the breadth of the market’s moves. Then there is the cost factor.

An investor no longer needs to spend thousands of dollars a month on expensive services to achieve most of what they need to do. With the Internet, free or low cost services (such as Yahoo Finance and the Wall Street Journal), a computer, and ETFs, an investor can accomplish most of what he/she needs to in making effective investment strategy decisions.

Now For the Soapbox Speech

Far too many individual investors use ETFs in the most limited fashion, which is to play a hot idea via a sector, industry, style, region, country, or asset class. That’s fine but that’s not helpful in the far more significant area of investment performance – the asset allocation decision. Representing 85% of investment performance, the asset allocation decision is where most investor SHOULD spend 85% of their time. Unfortunately, that’s just not sexy enough for many who would rather spend 85% of their time on the 15% that contributes to the investment performance of a well-diversified portfolio – the individual issues. This fascination with individual stocks is a disease I call “individual stockitis”. Focusing on what matters most – investment strategy and the asset allocation decision – is the cure for underperforming portfolios populated with individual “fast, mad money” ideas. (hmmm. I wonder what that refers to?) Utilizing ETFs for market signals empowers all investors in ways far beyond the hot idea du jour.

*click image to enlarge