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Risk Adjusted Sector ETF Performance: 3rd Quarter Update

Analysts often compare sectors for clues about the economy’s performance and future investments. The performance of these sectors must be adjusted for beta, or risk. What does this 2rd quarter adjusted performance tell us? Seeking Alpha readers know that I periodically analyze the performance of the nine S&P 500 sector ETFs to obtain clues about where the economy is going. Last years’ underperformance by the Materials Select Sector SPDR ETF (NYSEARCA: XLB ) was only the beginning of a very bad year (so far!) for those stocks. In contrast, after adjusting for risk, Consumer Discretionary (NYSEARCA: XLY ) stocks performed well late last year: and that outperformance has continued. (You can see the article on which this analysis is based here .) The most recent quarter was unpleasant for common stocks: so while all nine sectors fell, we must adjust this poor performance for the varying risk profiles of each sector before we compare it to the SPDR S&P 500 Trust ETF (NYSEARCA: SPY ). An illustration of how this is done will help, and point out a major red flag for the market going forward. Investors know that the healthcare sector has been one of the leaders in this bull market since it began in 2009. In the last three months the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ) fell 12%, two and a half percentage points more than the 9.5% for SPY. So yes, the market has lost some of its leadership: always a source of worry for bulls. But after adjusting for risk, the situation is even worse than it looks! According to yahoo finance XLV has a beta of .59; in a down market we should expect it to fall less than the broad indices. Not more! Specifically we should expect it to fall only 5.6%: (S&P 500 change) x (Sector ETF beta) = (expected risk adjusted ETF return) so (-9.5%) x (.59) = (-5.6%) So the healthcare sector underperformed, not by 2.5%, but by 5.6%! The full results are shown below. You can see that along with healthcare, energy (NYSEARCA: XLE ) and basic materials performed much worse than the market in the last few months. Risk Adjusted ETF Performance 3rd Quarter 2015 Select Sector SPDR ETF beta Actual Return Expected Return +/- Discretionary .91 -3.0 -8.7 +5.7 Technology (NYSEARCA: XLK ) 1.35 -9.1 -12.8 +3.7 Industrials (NYSEARCA: XLI ) 1.00 -11.0 -9.5 -1.5 Basic Materials 1.13 -21.0 -10.7 -10.3 Energy 1.02 -22.0 -9.7 -12.3 Staples (NYSEARCA: XLP ) .49 -3.5 -4.7 +1.2 Health Care .59 -12.0 -5.6 -6.4 Utilities (NYSEARCA: XLU ) .44 -3.0 -4.2 +1.2 Finance (NYSEARCA: XLF ) 1.19 -8.0 -11.3 +3.3 S&P 500 Index 1.00 -9.5 -9.5 zero All three underperformers can turn to special situations as an explanation: Healthcare? Hillary Clinton’s drug company bashing . Energy? The continued weakness in oil and natural gas prices. Basic materials? Continued weakness in Asia , especially China. Even given the dour economic news in these sectors, investors should remember their underperformance signals that this bad news has signaled the market has still not completely discounted this poor outlook. Focusing on healthcare in particular, the failure of this sector’s leadership has ominous signals for the market going forward. While some market indexes have signaled a bear market is now in progress–an issue I shall address in an article tomorrow– I am willing to give the market a bit of slack here. Why? Notice the strength in consumer discretionary stocks. This suggests families are benefiting from lower energy prices: a case of one good cancels out the bad, perhaps? The strength in tech is encouraging. Surprisingly the best indication might be the belated showing of the financial stocks. Remember: this whole debacle began years ago in the financial sector! For them to perform well in a weak market which still may face an interest rate increase from the FED , is encouraging. Keep your long and short powder dry until the market gives us clearer signals. More on this in my next article.

Apple iPhone buyers opting for more flash memory

A new survey shows that Apple (AAPL) iPhone buyers increasingly are choosing models with richer flash memory configurations, which should provide a boost to Apple’s earnings. RBC Capital Markets said Thursday that its recent survey of 1,055 prospective iPhone buyers found that 16.1% plan to purchase the top-end model with 128 gigabytes of flash data storage, up from 12% last year. RBC said 51.4% intend to buy the midrange 64 GB model, up from 48%

The Health Care Sector’s Weakness Could Be The Investor’s Best Friend

Summary The health care sector went through a significant meltdown during the recent weeks. A long term investor might consider it as an opportunity to invest in great companies. Here is a list of 4 non-expensive ETFs that are focused on the Health Care sector. Three weeks ago a good friend of mine bought shares of Mylan Inc (NASDAQ: MYL ). His goal was to invest in a defensive stock in order to mitigate the volatile market. Since the day he made the purchase the stock was hammered down and closed is currently at a total of ~20% lower. Mylan is a global generic and specialty pharmaceuticals company that is registered in the Netherlands. In 2007, following a big acquisition Mylan became the second-largest generic and pharmaceuticals’ company in the United States. It was a wise decision at the time. Here is Mylan’s forecast P/E growth rates in the coming years based on Nasdaq.com. A P/E of 8x for a double digit growth company is not too bad at all. MYL’s stock price free fall was no different compared to other Health care companies’ stocks. If looking at the behavior of the S&P 500 Health Care Sector the graph tells us that there was about 20% drop in the sector since the recent highs. On Wednesday, September 30th, there seemed to be some recovery after several bloody weeks. (click to enlarge) The drop is explained by Hillary Clinton’s ” price gouging ” tweet which led to concerns within the investors’ community regarding higher regulations on drug pricing. Is this massive drop justified or is it an out-of-panic oversell and therefore a great opportunity? Why do I think it is an oversell? Several reasons lead me to believe it is an extreme reaction over nothing and it is a temporary meltdown: The market is very volatile in the recent weeks and it seems that the focus is only on the bad news that are being a catalyst towards a dipper correction. Back in August it was the less-than-expected growth in China’s economy, than it was the Volkswagen ( OTCQX:VLKAY ) scandal and now it is this tweet. Any regulation would need to pass Congress where the Republicans still have the major votes. It would be at least couple of years until something would really change. Not all companies are taking outrages profits on their developed drugs. The amount of Research and Development the companies are investing is huge and therefore the economy of the business will eventually dictate the prices. It will not be the politicians. The sector is composed from different types of companies. Some develop an original medicine or drug and there are generic drug companies. Some are focused on specific niches and others have huge diversification. Even if there will be new regulations not all will suffer equally. Some would even benefit from it. For those, like me, who think that it is the later here are some ETFs that invest in this sector and should be profoundly examined by the long term investor. Why an ETF and not specific stock picking? While both the uncertainty and the volatility are high an investment in a specific sector can be better managed through an ETF. In cases where an investor would like to build a position that is composed by wide list of holdings, sometimes in several steps, an ETF would be a better way to do it. Buying into a sector’s ETF allows to build a position in a by-step model. Another reason to prefer an ETF is the level of familiarity with the list of companies in the sector. Though all the sector’s companies were hurt by the recent selloff most of the investors will not know which of the companies are best to recover and which could be impacted by new regulations (in case it is not just a hot balloon towards election). An ETF allows to have a wide exposure and by that increase the probability to ride the right companies towards recovery. When looking at the list of Health care ETFs I found a list of 38 ETFs. The full list can be found here . Some of the ETFs are focused on the traditional big health care companies like Johnson & Johnson (NYSE: JNJ ), Gilead (NASDAQ: GILD ) and Pfizer (NYSE: PFE ). Others are focused on biotechnology companies like BioMarin Pharmaceutical Inc. (NASDAQ: BMRN ) and Biogen Inc. (NASDAQ: BIIB ). Some are focused on health care equipment companies and some in small biotech small startups. An investor can decide based on his or her risk profile the best ETF that suits his or her needs based on its mix and focus. Filtering the list As I like to start a list filtering by eliminating ETF that charge high management fees I have sorted out all ETFs that charge more that 0.3% per year. Surprisingly I was left with only four ETFs. (click to enlarge) The last four are: The Health Care Select Sect SPDR ETF (NYSEARCA: XLV ), which replicates Health Care Select Sector Index. The Vanguard Health Care ETF (NYSEARCA: VHT ), which replicates MSCI US Investable Market Health Care 25/50 Index. The Fidelity MSCI Health Care Index ETF (NYSEARCA: FHLC ) that replicates MSCI USA IMI Health Care Index. The PowerShares S&P SmallCap Health Care Portfolio ETF (NASDAQ: PSCH ) which replicate S&P SmallCap 600 Health Care Index. This list allows an investor to pick an inexpensive ETF based on his or her own risk tolerance. A quick comparison between the four: In term of performance, PSCH delivered the highest return in the last five years due to its more risky nature. Surprisingly it wasn’t harmed harder than the others during the recent month drop. Both XLV and VHT are tending towards the large cap health care companies. XLV seems to be more conservative as it shown by its average 18x P/E ratio versus the average of 32x. VHT has a significantly higher amount of holdings which are mostly small and medium cap companies that are trading at higher P/Es compared to the JNJs and PFEs. Conclusions: The list of four non-expensive ETFs can be examined by a long term investor who believes that the Health Care sector’s meltdown is only a temporary one. In term of the potential of long term gains, some would prefer the small cap ETF, PSCH. If looking for high diversification, VHT seems to be the best one. I picked XLV in term of risk/return tradeoff. I prefer an exposure to the big and strong companies of the sector. In any case, I suggest to plan a strategy of building a position in multiple steps. The volatility is still here and the correction can be dipper than anyone anticipates. Happy investing.