SPY SPDR S&P 500

As we make further progress into the final quarter of 2012, it is worthwhile to point out that the year has been an eventful one in terms of domestic and global economic developments. The markets were flooded with a variety of events from across the globe that have led us to this uncertain time in the markets (see 4 Low-Volatility ETFs to Hedge Your Portfolio).

Among some of the major events this year, arguably one of the most important has been the ongoing European sovereign debt crisis. This situation saw at least some progress thanks to an open ended bond buying program by the ECB, although it remains to be seen if this will be the cure to the malaise.

Meanwhile, on the domestic front, the much talked about quantitative easing 3 (QE3) was implemented by the Federal Reserve to improve the broad economic market (see Long Term Treasury ETFs: Ultimate QE3 Play?). While this could help to spur the ongoing housing recovery, broad growth is still elusive, suggesting that the market outlook is still cloudy.

Similar Trends Across Risky Asset Classes

Amidst all this, a closer look at the performance of the riskier asset classes interestingly suggests that they have been following quarterly trends throughout the current fiscal year.

The equity markets started 2012 on a strong note as equities across the board surged after a brief broad market slump in the later half of last year. In fact, other riskier asset classes such as commodities and emerging market equities also benefited from this widespread optimism. As a result, most of the riskier asset classes ended the first quarter in the green.

However, the tides quickly turned in the subsequent quarter mainly thanks to lack of any concrete steps to tame the Eurozone debt crisis and a generic slowdown in most parts of the world.

If that wasn’t enough, the U.S economy grew just by a mere 1.5% in the second quarter. This has led to a sharp increase in volatility in the riskier asset classes across the board and caused investors to shift to a ‘flight to safety’ mode.

This also resulted in the U.S Treasuries (especially the long dated ones) witnessing a significant rally as they act as the ultimate safe haven investment avenues for investors in these distressed times. However, the stock markets recovered substantially in the third quarter as investors restored back confidence in the risky asset classes.

Also, with the implementation of QE3 in the latter half of third quarter, the markets were flooded with liquidity. The equity markets responded well and as expected, commodity prices surged. Thus, most of the ETFs tracking riskier asset classes witnessed substantial inflows in their asset base and were up as the third quarter ended (read Q3 ETF Asset Report: Investors Back in the Market?).

Thus we see that this quarterly “Up-Down-Up” trend within the riskier asset classes has been nothing less than a see saw ride for the investors.

ETFs Following Similar Trends

This phenomenon is exemplified from the ETF space as well. In this regard we have highlighted three ETFs belonging to the typical ‘risky’ asset class, which track the broad markets within their asset classes.

These are 1) SPDR S&P 500 ETF (SPY), which tracks the performance of the U.S equities, 2) PowerShares DB Commodity Index Tracking ETF (DBC), a futures backed fund which tracks the basket performance of 14 actively traded commodities and 3) iShares MSCI Emerging Markets ETF (EEM), which tracks the performance of broader emerging market equities.

Table 1: Returns Analysis and Moving Average

 

ETF	Asset Class	1Q	2Q	3Q	4Q (Quarter till Date)	Current Market Price	200 Day Moving Average
SPY	Domestic Equity	12.69%	-2.84%	6.35%	-1.82%	$141.35	136.77
DBC	Commodity	7.30%	-10.59%	11.38%	-3.84%	$27.58	27.74
EEM	Emerging Market Equities	13.20%	-7.80%	5.62%	-0.29%	$41.21	40.62

4Q (QTD) Returns, ii) Current Market Price, and iii) 200 DMA as of 26^th October 2012.

It is quite evident from the table above (Table 1) that all these ETFs have exhibited similar characteristics in terms of their quarterly movements, at least for the first three quarters. This is interesting, especially considering the fact that most of these ETFs do not have a very strong correlation among themselves (see more in the Zacks ETF Center).

Of course, the equity based ETFs (i.e. SPY and EEM) have a strong correlation of 91% among themselves, and the similarity in their quarterly movements is justified by their strong correlation.

However, SPY and EEM have weak correlation of 56% and 61% respectively with their commodity counterpart DBC. Despite this, its movement has exhibited similar trends with the equity ETFs.

Table 2: Correlation Matrix (using daily returns for 20 months)

 

ETF	SPY	EEM	DBC
SPY	100%	90.85%	56.55%
EEM		100%	61.79%
DBC			100%

What Lies Ahead?

The most important question at this point of time remains that will the similarity in quarterly trends continue to remain across these risky asset classes going into the fourth quarter? Or, will they follow the trend and plunge again in Q4 after an uptrend in Q3, just like the previous occasion?

Here are certain facts that hint towards the possible coming path. In just about a month into Q4, all the three ‘risky’ asset class ETFs have slid towards being in alignment with the persistent quarterly trend and started showing similar signs of a downtrend. In fact, on a Q4 quarter till date basis these three funds have slumped, as is evident from Table 1.

Furthermore, the two equity ETFs are within striking distances of breaching the crucial levels of the 200 Day moving Average, whereas the commodity ETF, DBC, has already breached that level and is trading below its 200 day MA. Thus, riskier asset classes might not prove be a good short term play in the final quarter.

Although we are still early in Q4, the weakness in the third quarter corporate earnings, speculation surrounding the presidential election, the fiscal cliff and the aftermath of the latest “Frankenstorm” Sandy are sure to keep the riskier asset classes volatile in the near term — a trait that is pretty much persistent with the second quarter (read Three ETFs to Watch in Hurricane Sandy's Aftermath).

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PWRSH-DB COMDTY (DBC): ETF Research Reports
 
ISHARS-EMG MKT (EEM): ETF Research Reports
 
SPDR-SP 500 TR (SPY): ETF Research Reports
 
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