Hottest ETFs of the Week – Tax Deal Edition

by ETF Base on December 12, 2010

Market action this week was very much driven by the “framework” announced by Obama which was met with surprising resistance from within his own party – especially surrounding the estate tax provisions and a payroll tax holiday that is viewed as only benefiting higher earners.  With a price tag estimated to be in the $850 Billion range, bonds tanked in rapid fashion immediately following the announcement.  While some would peg the bond selloff as a movement out of safety into equities and others would peg it as market “confidence” toward a better economic recovery scenario, pessimists would highlight that this is demonstrating the market reacting to a further impaired creditworthiness situation lending further doubt to the notion that the US will be able to fulfill its debt obligations further out into the future with no such “framework” to drive down the national debt following the sad outcome of the deficit commission weeks earlier.

Bonds did not recover meaningfully in the days to follow, so it will be telling to see if this was in fact the best time to short the US Treasury or whether this is the new range until we actually see improved economic activity in 2011 or a retrenchment into a double-dip in housing and possibly GDP growth as well.

With these bond market perturbations, we saw certain sectors rally which may well continue in the coming weeks.  Here were this week’s top conventional and leveraged ETFs:

Conventional ETFs:

KBE – SPDR KBW Bank – Up 6% – With Citigroup (C) making up 10% of this ETFs holdings, and many other financials rallying on the week, KBE was a top performing conventional ETF.  Banks, insurance companies, Business Development Companies, REIT companies and many other firms tied to loose money, tax breaks and a stronger 2011 all saw shares rally strongly on Obama’s announcement.  KBE is up 20% YTD.

XLF – Financial Select Sector SPDR – Up 4% -XLF varies slightly from KBE in that its top holdings are more heavily weighted toward JP Morgan (JPM) and Berkshire Hathaway (BRK.B) but the performance of the two tends to track pretty closely together over long periods of time.  However, on the year, KBE is outperforming at 20% up vs. 9% for XLF.

VNM – Market Vectors Vietnam – Up 4% – To get in a non-US, non-Financial ETF, I wanted to highlight Vietnam as a top performing single country ETF.  Many of these smaller Frontier Markets are starting to overtake the conventional BRIC countries since so much hot money flowed into those markets previously and especially following the runup to QE2.

Leveraged ETFs:

FAS – Direxion Daily Financial Bull 3X – Up 10% – This ETF provides 3 times the daily return of the underlying Financials sector.  Since financials were strong on the week on Obama’s announcement, FAS took top billing in the leveraged ETF category.  As always, I caution that leveraged ETFs make for a decent trade over a few days’ period but should be avoided at all costs as a long-term investment.  There is an oft-misunderstood phenomena tied to the daily resets that virtually guarantees that over time, all leveraged ETFs go to zero, hence, constant reverse splits.  This is due to the compounded effect of the daily price resets.  Buyer beware.  to demonstrate this further, the KBE cited above is up 20% on the year while a 3X Financials FAS is up only 8% due to this value decay.

TNA – Direxion Daily Small Cap Bull 3X – Up 8.5% – The next sector that performed strongly in the leveraged genre was the small cap stock segment.  With equities up in general, small caps have tended to outperform during this recovery, especially as prospects for credit and growth continue to show promise.

TMV – Direxion Daily 30-Yr Treasury Bear 3X – Up 5% – Bonds sold off strongly on what amounted to another massive stimulus program.  With close to another Trillion dollars being spent over the next few years and no mention of any form of future austerity or deficit reduction plans, it was completely reasonable to expect to see bonds sell off.  The question is whether this is now largely baked into market expectations or whether bonds can somehow regain traction with the QE2 program still in place well into 2011.

Disclosure: Author has no holdings in any of the aforementioned ETFs or equities.

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