ETFG Behavioral Scores/End of 3rd Quarter

Tick, tock and that is not the sound of the new Apple iWatch (does it even make a sound?) but of the 3^rd quarter that is rapidly drawing to close.  The end of a quarter is a magical time for managers who have outperformed their benchmark but for those with ground to make up, it can be terrifying.  With only a little more than three months to go before year end, some managers will stick to their playbook while others will start looking at the market’s strongest performers to add to their portfolio in hopes of making up lost ground.  At ETFG, we have an app (or whatever) for that, so let’s take a look at the ETFG Behavioral 25 to see what’s trending well.

It’s been a while since we talked about the Behavioral score, so as a quick refresher; the score is composed of two separate but equal groups of indicators:

• Technical Scores - measure momentum, the strength of any recent moves and stretched the price of the ETF has come relative to its history.  Despite what you hear about efficient markets in Investing 101, momentum has been demonstrated to persist for extended periods of times or put another way; strong outperformers will often continue outperforming over an extended period of time.
• Sentiment Scores - where we look at put/call ratio, short interest and implied volatility for their value as contrarian indicators.

Looking at the list of the 25 ETF’s, that score highest on the behavioral factors, there are a few clear patterns worth noting - let's review one of them: 

After a challenging period in March and April that saw much of the early 2014 gains wiped out, biotechnology names continue to dominate with three names in the top 10 with iShares NASDAQ Biotechnology ETF (IBB) in first place with a score of 81.4, SPDR S&P Biotech ETF (XBI) in second place and the Market Vectors Biotech ETF (BBH) in 9^th place.  What propelled them to take so many of the top spots?  Their strong performance has been a factor with IBB, XBI and BBH up 6.76%, 5.37% and 11.96% respectively this quarter compared to a broader healthcare ETF such as Vanguard Healthcare ETF (which happens to be number 10 on the list of top 25 names) which is up 5.81% or when compared to the broader S&P 500 up 1.81%.  Even beyond the top ten you’ll find more healthcare and biotechnology names such as the SPDR S&P Pharmaceuticals ETF (XPH) or the PowerShares Dynamic Biotechnology & Genome Portfolio (PBE) might be worth a look.

Biotechnology names have been outperforming the healthcare sector and broad equity markets for several years as M&A activity has heavily reduced the numbers of outstanding biotech companies.  IBB has delivered annualized returns of over 43.29% over the last 3 years compared to 22.48% for SPY and while performance in 2014 has been strong, IBB’s momentum scores are still below their old highs indicating that fund might continue to push higher.  And since all three of the top biotech ETF’s are showing similar technical scores, their sentiment scores are what determine their overall rankings at least for now.  IBB takes the number one slot thanks to its high short interest ratio as more “investors” go short IBB with the expectation that its outperformance will soon end.  As recently as August 29^th, NASDAQ showed that the short interest was over 11 million shares compared to an average daily volume of 914,000 shares giving a short interest ratio of 12.09 (or days to cover all those shares) and close to the highest levels seen for IBB.  Remember, the higher the short interest, the higher the ETF could go in the event that “investors” decide to cut their losses and buy back shares to cover their positions.

As we have said before, you can’t use just single out one factor when making investment decisions but as the 3^rd quarter begins to wind down, are you willing to wager on underperforming managers deciding to stand out from the herd?

Thank you for reading ETFG Perspectives.