McCall’s Call: Bottom-Feeding on ETFs

October 13, 2011

With stocks near bear-market territory, is it time to do some bottom feeding?

The major U.S. indexes unofficially moved into bear market territory last week when they fell 20 percent off their highs. The question is whether that sets up buying opportunities for investors with cash on hand to reinvest.

The answer is not as clear as yes or no. But, when headlines are telling one story, it’s often the time to go against the grain and do the opposite.

With that strategy in mind I found four ETFs that I am willing to begin to bottom feed on, including a number of sector ETFs and my favorite junk bond ETF.

What’s crucial for bottom feeders to grasp is that they may be early or even wrong, so be patient, and set up sell-stops to stop the losses should they start quickly piling up.

Consumer Resiliency?

The SPDR Consumer Discretionary ETF (NYSEArca: XLY) may sound a bit risky due to its name. If the ETF is composed of stocks that sell discretionary goods and services, how could they do well in the current economic environment?

That’s a fair question and, moreover, the ETF hit a new 52-week low last week. However, the top holdings in the ETF are doing well and with retail numbers holding their own, XLY could be an underdog that comes out ahead.

The top two holdings are stocks that are near their all-time highs, McDonald’s (NYSE: MCD) and (NASDAQ: AMZN). XLY has a total of 79 stocks, and has an annual expense ratio of 0.20 percent. The current dividend yield is 1.61 percent.

If the ETF can break through the $38.50 resistance level it could make a run at the all-time high of $41.78 set earlier this year.

Energy Bull

The energy sector tends to fall with the overall market because investors perceive the demand for oil declining with the stock movement. This dynamic pulled down the Vanguard Energy ETF (NYSEArca: VDE) to its lowest level in a year last week before it bounced back with a vengeance in the following five days.

If you believe the world economy isn’t crumbling, then you should also believe oil will stay above $70 per barrel and will likely hit triple-digits again soon.

With oil above $70, many of the large-cap energy stocks will report strong earnings, and VDE gives investors exposure to a basket of the big names. The ETF has a total of 169 stocks in its allocation and has an expense ratio of 0.24 percent.

I have a sense there could be one more down draft in the energy sector, and when that happens, that will create a buying opportunity in VDE.

Financial Sector

When the “risk-on” trade returns, the biggest winners are the financial stocks. The very stocks most investors see at the center the market crash in 2008 and its aftermath could be the biggest winners when the bulls return to the market.

The SPDR Financial ETF (NYSEArca: XLF) touched a new two-year low last week, before bouncing 13 percent in the next four days.

I can’t predict that financials are at a bottom, but at some point in the next couple of months there will be a time to begin scaling into the sector. The time may be now, or it may be early next year.

Nobody knows the future, but if you believe the financial system will not completely collapse, owning some financials in the coming months as a long-term investment could be a profitable strategy. The ETF is composed of 83 stocks and charges a 0.20 percent expense ratio and pays out a 1.63 percent dividend yield.


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