ETFs vs Stocks - How To Profit With Sector ETFs
By Simon Maierhofer
October 21, 2008

In 1908, Ford’s Model T was the car that “put America on wheels”. Henry Ford’s vision was to build a car for the great multitude. In 1924, Massachusetts Investors’ Trust heralded the arrival of the modern mutual fund. The fund went public in 1928, just in time to get hit by the great depression.

It took decades for the mutual fund industry to recover. By the end of the 1960s, there were approximately 270 funds with $48 billion in assets. The ability and easy to buy entire baskets of stocks, selected by full-time money managers appealed to layman investors.

Mutual funds became mainstream after 1975 when a change in the Internal Revenue Code allowed individuals to open IRAs. In 1976, John Bogle formed the first index fund, now called the Vanguard 500 Index Fund (Nasdaq: VFINX)

Ford’s (NYSE: F) concept to put America on wheels worked back then but today Ford is struggling to survive. The concept of owning baskets of stocks worked over the past decades, but does it remain the best strategy in a steep bear market?

iShares, Vanguard, First Trust, Rydex and PowerShares offer full lines of sector ETFs similar to the popular Select Sector SPDRs. It would be too much to address the advantages and disadvantages of the individual sector ETF suites at this time (for an exhaustive study refer to the October issue of the ETF Profit Strategy Newsletter).  

The consumer staples sector has held up best amidst the recent financial and economic turmoil. Four of the top ten holdings of the Select Sector Consumer Staples SPDRs (AMEX: XLP) performed better than XLP, the rest worse. XLP is down about 9% YTD.

Protect Your Wealth And Profit With ETFs >>> The ETF Profit Strategy Newsletter - Sign Up Now

The Vanguard Consumer Staples ETF (NYSEarca: VDC) also provides efficient exposure to consumer staples. Wal Mart (NYSE: WMT) and Anheuser Busch (NYSE: BUD) not only managed to outperform XLP and VDC, they are also up for the year.

A similar picture presents itself in the health care sector. Johnson & Johnson (NYSE: JNJ), GILD, ABT and MDT managed to outperform the Select Sector Health Care SPDRs (AMEX: XLV) while the remaining top 10 holdings underperformed. XLV is off about 26% YTD. Abbott Labs (NYSE: ABT) is up nearly 10% while Amgen (Nasdaq: AMGN) has lost more than half of its value.

McDonalds is the only bright spot in the consumer discretionary sector. The Consumer Discretionary Select Sector SPDRs (AMEX: XLY) are down about 40% YTD. To savvy investors this should be old news as consumer discretionary spending is the first to dry up in recessionary environments.

While the iShares DJ Consumer Services ETF (NYSEarca: IYC) matched the performance of XLY, subscribers to ETFguide’s Ready-To-Go Portfolios (model portfolios) cashed in with the recommendation of the ProShares UltraShort Consumer Services ETF (AMEX: SCC), up 54% since its recommendation on September16, 2008.

Profit With ETFguide's Model Portfolios - Sign Up For The Ready-To-Go Portfolios

Investors unfortunate enough to own stocks of Fannie/Freddie, Lehman Brothers, Washington Mutual, Wachovia (NYSE: WB), AIG (NYSE: AIG), Citibank (NYSE: C) and many others have come to appreciate the value of sector ETFs the hard way. The Financial Select Sector SPDRs (AMEX: XLF) have shed 50% in the past year. No bones about it; this is bad, but not as bad as 90%+ losses in the above names.

As with any basket of stocks, limited down side risk brings along limited upside potential.  Greater peace of mind is a much welcome side effect. The unraveling of the financial markets is likely still in its beginning stages. Chances are there are more Lehman’s and AIG's in disguise ready to fall of the cliffs.