Sectors play an enormous role on a stock’s performance over short periods of time. Being able to correctly analyze the role sector gravity has on individual stocks within the sector will greatly assist you as an investor is determining entry and exit points.
Historically, sector gravity was traditionally related to 50% of a stock’s move in either gains or losses. However, sector gravity has more recently played a 75% to 80% move in either direction during a short period. Therefore, sectors play a pivotal role in shaping the short-term direction of a stock.
One of the biggest advantages of sector ETF’s is the fact they are highly liquidity. Liquidity enables institutional managers to quickly trade ETF’s at a more rapid pace than individual stocks. ETF owners can more quickly locate potential buyers or sellers than individual stocks because of the broad exposure to a certain sector. ETF’s have emerged for every nook and cranny of the market. Whether it is the banks, commodities like gold, or retail, there are all kinds of ETF’s for investors to choose from. Much like futures contracts, ETF’s can also be purchased using leverage. Leverage allows investors to purchase more shares of ETF’s than cash alone, which causes ETF’s to have more of a pull on individual stocks.
Despite ETF owner’s beliefs that fundamentals of individual companies do no matter, fundamentals play a pivotal role in picking individual stocks over the long-run. Although ETF’s do affect stock performance over a relative short period, good fundamentals of well-run companies will always outperform ETF’s in the long-run.
One example of an ETF’s pull on certain stocks is the oil industry futures of WTI Crude and Brent Crude. When these two futures contracts rally, then oil companies and firms related to the oil patch industry traditionally rally during the intraday as well. Likewise, if WTI Crude and Brent Crude are slipping and trading in a more volatile nature, then firms related to the oil industry will see their price fall despite strong fundamentals and revenue performance. The advantage to ETF’s is the fact you can relish in strong performing firms while not be stuck with an individual firm who is struggling.
One way to avoid being caught in the ETF sector gravity pull is to determine which companies have strong long-term prospects that will continually outperform the ETF’s gravity pull. Look for companies with strong fundamentals, top notch management team, and always do your own homework on the firm. By utilizing this selection method, you will be able to make informed decisions and consistently outperform ETF’s.
ETF’s can also be a powerful to analyze entry and exit points in stocks. If an ETF is pulling a stock that is fundamentally flawed or poorly run higher, then this may be the perfect time short the stock when it eventually comes back to reality. The same can be said for stocks who trade on discount thanks to the ETF sector pull even though their fundamentals prove they are a worthy stock to own. This creates the perfect entry point for investors where they can purchase the stock at a nice level before other investors realize how cheap this equity is trading. Recent example of stocks trading at discount despite strong fundamentals were bank stocks who were hit hard by lower performing banks in the ETF and worries of the Federal Reserve not raising interest in the relative short-term. Another example of ETF’s pulling weak stocks higher are retail firms like Sears and J.C. Penney’s, who stocks should not trade anywhere past next year’s earnings nor be considered high performing companies like retail giants Costco and Target.
ETF’s advantage to exposure to an entire sector does assist in allowing investors catch immediate short-term gains instead of waiting for an individual stock to move higher in the same sector. Another advantage to ETF’s is helping establish entry and exit points when stocks become too cheap not to own and when stocks are too expensive to own. Finally, ETF’s will only help in the short-run; individual stocks of companies with strong fundamentals and management teams will always outperform ETF’s over longer periods of time.
