Strategists’ ETF Investing Guide for Q4 2012

Steven Bobson, Europe & Americas Editor
September 26, 2012 /

As the adage goes, “bull markets climb a wall of worry.” The robust stock market rally this year took the bears, retail investors and hedge fund managers alike by surprise.

The world’s largest ETF,SPDR S&P 500 ( SPY ), advanced 16% year to date, while mutual fund investors pulled money out of stocks in favor of bonds and most hedge funds underperformed the market.

What should ETF investors do now? We asked several ETF portfolio managers for their read on the market and their best ETF investing idea for the fourth quarter.

Matt Reiner, portfolio manager at Wela Strategies in Atlanta with $1 billion under management: “We remain moderately bullish heading into fourth quarter as we think that some certainty created by the election coming to a close will help propel equities to a small rally to end the year.”

Interest rates will remain low for the foreseeable future, leading investors to continue searching for yield in Q4 and beyond.

The one area of the market that seems to be stabilizing and finally finding a bottom is the real estate market, which has seen steady improvement thus far in 2012. Through August,Vanguard REIT ETF ( VNQ ) has appreciated 16.93% when including dividends. But in a time when investors are striving for income and with the real estate market recovering,iShares NAREIT Mortgage ETF ( REM ) seems poised to continue appreciating in Q4.

Along with benefiting from an improved real estate market, REM carries a trailing 12-month yield in excess of 10%. We believe that pairing REM with VNQ provides a good allocation to the REIT space, while also being able to continue earning a stream of income in this low-rate environment.

•Ronald Lang, principal at Atlas Wealth Management in Philadelphia with $20 million AUM, said: “As we head into the final quarter of the year, there are three major concerns for the market: the presidential election, the “fiscal cliff” and the European debt crisis. All three have dominated the headlines and have become critical factors in analyst models in determining the direction of the market.

“Better than half of the key analysts we track have forecast a decrease in corporate earnings and possibly a 2% or less gross domestic product (growth) in 2013.

“If we take the optimistic view on our three key factors and assume institutions and investors will rally behind the presidential victor, the fiscal cliff gets resolved within a month after the election somewhat amicably (at least keeping dividend tax rate at or around 15%) and Europe begins executing a plan to keep almost everyone happy and in the euro, the S&P 500 may rally another 5% to 8% to 1500-1540 by the end of this year.

“Another looming factor may be a downgrade on the U.S. debt, but that is fodder for another conversation, as it will be even more difficult to forecast how that may impact our markets if the first three factors are not amicably resolved. Many people will go to cash if this happens.

“So we decided to take the optimistic view. Small caps iniShares S&P SmallCap 600 Index ( IJR ) have consistently beaten the S&P 500 Index over the last five years and should continue that charge.Vanguard Mid-Cap ETF ( VO ) will benefit greatly from a bullish run.

“Keep away from both the small- and midcap ETFs if we do not get resolution or some keen insight to a resolution on our three critical factors. These ETFs will fall harder than the large-cap ETFs and underperform the S&P 500.”

•Tahar Mjigal, director of risk management at International Capital Management in Dallas with about $100 million AUM, commented: “Since the June 2012 low, the U.S equity market has experienced a significant rally fueled by investors’ hopes of another round of quantitative easing (QE3) by the Federal Reserve and further easing by the European Central Bank. This rally has challenged many investors that have remained on the side lines for much of the year in anticipation of a market correction.

“Despite what many believe are deteriorating fundamentals, markets have pushed higher in response to a combination of worldwide government stimulus and to a lesser extent corporate stock buyback programs that have significantly increased since 2009.

“The S&P 500 is attempting to test 1500 — its high set back in 2000 — for the third time. It is approaching the top end of the range of the secular bear market that started in 2000 despite higher unemployment, larger deficits in developed nations, uncertainty stemming from the impending U.S. fiscal cliff, weaker global economic growth, potential Middle East crisis and the ongoing European debt crisis.
The problems will continue to weigh on the global economy the next few years. Nothing has changed that would support a market breakout to the high side from these long-term resistance levels.

“For now, however, the market is stable as investors continue to focus on continued stimulus. Governments and central banks around the world are doing whatever it takes to stand behind the rally.

“In the near term, we expect the S&P 500 to pull back before moving higher to test the 1500 level early next year, if the Republicans win (the presidential election).

“Certain investments are poised to outperform the market and provide less correlated returns to the broad market. These includeiShares Nasdaq Biotechnology (IBB),SPDRs S&P Homebuilders (XHB),iShares Dow Jones U.S. Healthcare (IYH),WisdomTree Emerging Market Local Debt (ELD) andiShares High Dividend Equity (HDV).
We remain defensive and are avoiding small-cap funds and international developed markets, where we feel the most downside exists.”

Kathy Boyle, president of Chapin Hill Advisors in New York, added: “To me this seems very much like 2007. We’re building a top. The market peaked in April, troughed in early June and rallied all summer with little volatility on hopes of more liquidity from the governments. We may have one more push up into September and possibly October, but I think we are more likely to see a significant correction from the 1440 level on the S&P.

“Everyone is anticipating more liquidity to keep coming out of the central bank. Piling up debt on top of debt: Does that sound like a good strategy? Would you do that in your own business or life? Of course not.
Yet, we are delaying action on the underlying problems. We need to cut spending. We have trillion dollar deficits, systemic problems with underfunded pensions, health care obligations, high unemployment, a huge slowdown in China, a pending exit of Greece from the European Union and a fiscal cliff.

“And those are the “knowns.” What about the unknowns like the recent hurricane, which could have been worse? Israel and Iran heating up. What if Spain exits the EU? All of these things could cause a market implosion.
Investors should hedge their portfolios with eitherActive Bear ETF (HDGE) orSPDR Gold Shares (GLD).”


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