Monday, October 17, 2016 - ETFs are ultimately subject to the risks and rewards that are inherent to their underlying constituents. With the third quarter earnings season now underway and given the sensitivity equity prices exhibit around earnings releases, let’s take a look at a few key ETFs that were most affected by the first round of Q3 earnings releases.
Alcoa (AA), widely viewed as a bellwether for the materials sector, kicked off the week reporting results that fell short of analysts' estimates. Shares ended the week down 17% at $26.45 after the disappointing news. With 67 ETFs holding AA and nearly 5% of its $11.59B market cap tied to ETFs, there were no shortage of ETFs impacted by these results. While diversification can eliminate single stock risk, ETFs with more concentrated exposures, such as market-cap weighted sector ETFs, can be particularly sensitive to short-term equity volatility. For instance, the SPDR S&P Metals and Mining ETF (XME), where Alcoa has its largest single fund weighting comprising 4.24% of the $647.86M XME fund, fell in immediate response to AA's results and finished the week down 5.6%. Conversely, the Guggenheim S&P 500 Equal Weight Materials ETF (RTM), despite having similar constituents, finished the week down only 2%. The plunge in XME's price likely reflects a confluence of factors, including contracting Chinese industrial demand, Alcoa's position as a materials sector bellwether, and XME's market-cap weighting scheme and large-cap concentrated exposures. RTM's performance differential may offer an example of how smart-beta ETFs that employ alternative weighting-schemes can buffer fund performance during earnings season.
While the performance of Alcoa and its related ETFs illustrate the downside risk ETF investors are exposed to around earnings season, Friday's surge in financial sector-related ETFs shows the upside potential of earnings announcements. On the heels of better than expected earnings announcements from three flagship banks, Citigroup (C), JP Morgan (JPM), and Wells Fargo (WFC), the Financial Selector Sector SPDR Fund (XLF) rose 0.5% on Friday. This immediate upswing is no surprise, as these three banks together reflect nearly a 25% weighting in XLF. Other notable financial-related ETFs, like the $235.59M Fidelity MSCI Financials Index ETF (FNCL) and the $2.41B SPDR S&P Bank ETF (KBE), each rose 0.5% on Friday following the news. These gains were posted despite the multitude of issues that continue to beleaguer the banking sector, including mounting regulatory burdens, an accommodative Fed and low net-interest margins and several high-profile legal challenges like Wells Fargo's cross-selling scandal and the DOJ's probe into Deutsche Bank's mortgage lending activities.
With only 7% of S&P 500 companies reporting earnings thus far, expect plenty more volatility in equity markets ahead. For investors looking for companies with strong cash flows and positive earnings momentum, it is worth taking a look at WisdomTree Earnings 500 Fund (EPS), which selects and weights large-cap companies that have generated positive cumulative earnings over their most recent four fiscal quarters.
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