ETFs that were badly beaten up in 2018, and currently rank among the weakest in terms of relative strength, are poised for big gains in the short term, according to a study by Ned Davis Research. “The Q4 decline resembled the 2011 and 2015/2016 bear markets. In those cases, the bottom quintiles outperformed the top quintiles for 3-4 months,” said Ned Davis ETF strategist Will Geisdorf, per a detailed story in Barron’s.
This group includes ETFs focused on energy and Latin America such as the SPDR Oil & Gas Equipment & Services (XES), Invesco Solar (TAN), VanEck Vectors Oil Services (OIH), iShares U.S. Oil & Equipment Services (IEZ), and the Global X MSCI Argentina (ARGT). All of these already have shown they can outperform by rising more than 20% year-to-date, and they still rank in the bottom quintile of relative strength rankings measured over nine months, per Barron’s.
5 ETFs That May Post Big Short Term Gains
· SPDR Oil & Gas Equipment Services (XES), 26%
· Invesco Solar (TAN); 25.3%
· VanEck Vectors Oil Services (OIH); 21.7%
· iShares U.S. OIl & Equipment Services (IEZ); 22.3%
· Global X MSCI Argentina (ARGT); 18.8%
Short-Term Opportunity in the Weak
Strategies utilizing relative strength typically involve buying stocks that post the largest returns over a predetermined period of time. While strategies focusing on high relative-strength can work long term, there is a big downside: these ETF leaders often turn into laggards following large market declines like the one in December. The length of the underperformance usually tracks with the magnitude of the decline, according to Ned Davis.
This trend opens a window of opportunity for ETFs with weak relative strength to outperform for a short period. “It’s a mean-reversion opportunity, but tricky because there’s a very short window of three months,” Geisdorf told Barron's. “Those ETFs that have been beaten up the most and weakest in terms of relative strength tend to bounce the hardest.”
The SPDR Oil and Gas Equipment and Services ETF has made the strongest comeback of Ned Davis’ top picks. It's up 26% YTD, yet still down 24.4% over 12 months. While forecasts for flat oil prices in 2019 may initially discourage oil industry investors, bulls see opportunity in better-capitalized companies with strong balance sheets and renewed cost discipline. Top holdings of the XES ETF include Weatherford International PLC (WFT), McDermott International Inc. (MDR), Rowan Cos Plc (RDC) and US Silica Holdings Inc. (SLCA).
It’s important to note that diving into this strategy presents a narrow window of opportunity, meaning that investors may have to jump quickly to reap rewards. Given how fast the market is changing these days, the need for quick action is ever more important.