GAMP Guide to the Market (pt. 2)

XLF 1yr/1wk

Now that you know about index tracking ETFs, we can move on to sector tracking ETFs. 

What the hell is a sector? 

A sector is a portion of the market that consists of a single industry. For instance, the Healthcare sector, Financial Sector, Energy Sector, Consumer Discretionary sector, Pharmaceutical sector, and the the list goes on and on. 

Why is this important?

It is important because by using sector specific information and industry trend analysis, we can determine which industries (given current micro and macroeconomic conditions) will be the most successful over a given period of time. 

As pictured above, XLF, a financial sector tracking ETF, tracks mostly all of the entire financial industry in the United States. By buying this security, you are exposing yourself to not only one bank, but the whole entire financial sector as a whole. 

Now why would someone want to do this?

Let’s say Janet Yellen came out tomorrow and said the Federal Reserve Bank will keep interest rates constant for another two years or so. XLF, along with all financial companies around the country, would instantly benefit due to the direct effect of low interest rates on their ability to borrow money and lend it out to other firms and individuals. 

Now let’s say the opposite happened. Let’s say Janet Yellen decided to raise rates to 10% tomorrow (….something something Venezuela), the financial sector would collapse. Many financial institutions would become insolvent due to the credit risks they took during the period while interest rates were low.

Without trying to get into too much detail, this is an example of a sector related trend (although if Yellen raised rates to 10% we’d all be homeless and starving). 

This is another example of an industry specific trend. 

(Although to be quite honest, West Texas Intermediate and Brent Crude Oil futures prices affect almost every aspect of our lives. But for simplicity’s sake, I’ll just pretend like oil isn’t that important.) 

Everyone has heard of OPEC. Most recently, they’ve held meetings in Algeria with the purpose of reaching a deal on oil production output cuts in order to stabilize spot and forward prices and ultimately raise the price of oil, further boosting the Oil & Petroleum Exporting Countries’ revenues. 

Depending on the agreements that were made, all Energy Sector related firms will be affected. If they actually limit output, it would result in a decrease in global supply and a rise in price and due to the inelasticity of oil (see: Alabama gas shortage), it will result in gains for anyone holding positions in oil producing companies and/or oil future tracking ETFs. 

(We’ll get into commodity ETF trading a little later.)

These are just rudimentary examples of the umpteen-million sector trends that exist everywhere, all around you, waiting to be exploited. Obviously I haven’t even begun to name all of the many industries that exist in our globalized capitalistic society, but this should give you an idea of what to look for when you’re browsing through sectors and trying to determine a position to enter.

–Agee