Economic Warning Signs: 3 Underperforming ETFs

Source: Thinkstock

Source: Thinkstock

Recently I wrote an article in which I pointed out three ETFs that significantly outperformed the market during the first half of the year. These funds were:

  1. The Market Vectors Junior Gold Miner ETF (NYSEARCA:GDXJ)
  2. The iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT)
  3. The SPDR S&P 500 Oil and Gas Exploration and Production ETF (NYSEARCA:XOP)

While it would have been great to own these funds, one thing they have in common is that their outperformance suggests that the economy isn’t so strong. After all, people buy gold and Treasuries when they are concerned about the economy and when they are reluctant to own stocks. Furthermore, the XOP rose primarily because the oil price rose, and a rising oil price makes virtually everything in the economy more expensive, which could end up weakening future growth.

In this article, I have pointed out three ETFs that are underperforming. Unfortunately, the fact that these funds are underperforming further indicates that economic growth may be tepid or negative.

Source: Thinkstock

Source: Thinkstock

1. The SPDR Retail ETF (NYSEARCA:XRT)

The XRT is only down slightly—about 1.5 percent for the year, although this is a pretty lousy performance for an up year. Retail stocks outperform when the economy is strong and they underperform when it is weak. These stocks’ valuations can fluctuate wildly depending on the strength of retail sales. After all the cost of keeping a store open remains relatively constant while the cost of selling a particular good is well below the retail price. So if a company increases its sales by just a few percentage points, this can catapult earnings higher and send shares soaring. This is what happened with a lot of retailers over the past couple of years.

But now we are seeing weak retail sales figures, and as a result retail stocks have begun to underperform. Some have shown incredible weakness that has resulted from minor misses in their earnings estimates or in their forward guidance. This is largely why retail stocks have underperformed the S&P 500 by about 7.5 percent for the year. This trend will continue so long as retail sales continue to come in weak. Another thing to point out is that analysts have had very high expectations for these stocks and as a result they have traded at high valuations. If this changes the XRT can fall dramatically.

Source: Thinkstock

Source: Thinkstock

2. The SPDR Homebuilders ETF (NYSE:HRB)

While investors were enthusiastic about strong May pending home sales, the fact remains that this doesn’t change the intermediate term trend of housing prices finding a top. As a result homebuilders have underperformed, with shares of the XHB falling by nearly 2 percent for the year.

Many of these companies are reporting earnings that look good on the surface but underneath the hood there are some problems, and savvy investors are seeing through the fluff and taking profits. Homebuilder earnings have benefitted tremendously from rising home prices even if their businesses are not growing. For instance recently homebuilder KB Homes (KBH) reported what looked like very strong earnings, and the stock rose. But the company actually reported a decline in home sales. Earnings rose because of rising home prices. If this trend turns around (and we are seeing signs of this) the upward earnings trend could reverse. This is what the market is predicting, and I suspect that those betting against the homebuilders are right.

Source: Thinkstock

Source: Thinkstock

3. The Global X Social Media ETF (NASDAQ:SOCL)

While many investors are familiar with the social media stocks and companies, they probably aren’t familiar with this fund. While it is smaller it owns stocks in companies that are popular among investors such as Facebook (NASDAQ:FB), Pandora (NYSE:P), LinkedIn (NYSE:LNKD), Yandex (NASDAQ:YNDX) aka “Russian Google (NASDAQ:GOOG)”, and Yelp (NYSE:YELP).

While the fund performed very well last year, it is pulling back this year to the tune of 7 percent. The reason is probably less related to the economy and more about the fact that a lot of these stocks were simply overheated. Many of these companies still generate no earnings or trade with price to earnings multiples in the high double digits, or even in the triple digits. As investors have become more cautious this year they have taken profits in these growth stocks and are likely parking some of the proceeds into the three funds mentioned above or similar assets.

This fund has recovered strongly since April, but investors should be aware that the fund is trading near its 200-day moving average and is ripe for a pullback. If you are interested in owning this fund or some of the stocks in it, just be aware that they are very popular and have a lot of analyst coverage, and so they are probably still over-owned. Wait for a pullback and for some of the bulls to turn bearish. This should engender an excellent buying opportunity for the long term.

Disclosure: Ben Kramer-Miller has no position in any of the stocks or funds mentioned in this article.

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