Trading Lesson
Which
Exchange Fund to Track and Hold
by Thom Hartle
An
exchange traded fund is an investment product that holds a pool of
securities designed such that the return on the shares is
comparable to the performance to an index. For example, an
investor who purchases SPDRs does so with expectation that the
returns will closely match the performance of the S&P 500, the
standard benchmark for investors tracking the stock market. The
general idea is that you own the top 500 companies in America.
Today's two most popular exchange
traded funds are the Standard & Poor's Depositary Receipts (Nasdaq:
SPY), often referred to as SPDRs and the NASDAQ-100 Index Tracking
Stock (Amex: QQQ). Investors purchasing the QQQs, are interested
in returns similar to the Nasdaq 100 index, which represents the
technology sector. There are no financial stocks in the Nasdaq 100
index.
But, there is another fund that
traders should track as both an indicator of the state of the
market and for investment potential, and that is the Rydex S&P
Equal Weight ETF Trust (Amex: RSP). Here we'll compare the three
funds and show why the Rydex ETF should be on your radar.
Investors purchasing the QQQs,
are interested in returns similar to the Nasdaq 100 index, which
represents the technology sector. There are no financial stocks in
the Nasdaq 100 index. There are over 150 exchange traded funds
representing opportunities for investors to participate in markets
ranging from fixed income securities to foreign stock markets.
The S&P 500 index is a market
capitalization-weighted index, which means that a stock's price is
multiplied by the total shares outstanding. In other words, the
larger the number of outstanding shares, the larger the effect the
individual stock price has on the movement of the index. This is
known as a market capitalization-weighted index Table 1 represents
the weighting of the top ten stocks in the S&P 500, which is
composed of 500 stocks.
Table 1: Top Ten
Stocks by weighting (Source: Nasdaq.com) |
1 |
General Electric Co
|
3.01% |
2 |
Microsoft Corp |
2.88% |
3 |
Exxon Mobil Corp
|
2.63% |
4 |
Pfizer Inc |
2.61% |
5 |
Citigroup Inc |
2.42% |
6 |
Wal Mart Stores Inc
|
2.22% |
7 |
Intel Corp |
2.04% |
8 |
American International Group
Inc |
2.04% |
9 |
Cisco |
1.62% |
10 |
International Business
Machines |
1.55% |
|
Total |
24.21% |
The top ten stocks represent
24.21% of the calculation of the S&P 500. In other words, the
performance of General Electric, Microsoft, and Exxon will have as
much impact on the S&P 500 index as the performance of remaining
stocks 497 stocks in the index.
Table 2:
Industry Groups (Source: Nasdaq.com ) |
1 |
Financials |
20.62% |
2 |
Technology |
17.62% |
3 |
Health Care |
13.27% |
4 |
Consumer Discretionary
|
10.98% |
5 |
Consumer Staples
|
10.98% |
6 |
Industrials |
10.85% |
7 |
Energy |
5.77% |
8 |
Communication Services
|
3.43% |
9 |
Materials |
3.01% |
10 |
Utilities |
2.77% |
|
Total |
99.55% |
Table 2 is a breakdown of the S&P
500 by Industry Groups.
At the top of this list are the
financials, which make up slightly over 20% the S&P 500. Movements
of the financial industry will therefore have the greatest impact
on the S&P500, followed by technology, then by health care, etc.
For example, this past quarter the performance of American
International group (NYSE:AIG), under pressure due to an ongoing
investigation, and has pulled the S&P 500 down, as seen in Chart
1.
THE QQQs
The NASDAQ-100 index holds
technology stocks only, and is also a market capitalization
weighted index. Table 3 shows the top holdings.
Table 3: Top Ten
Stocks by weighting (Source: Nasdaq.com) |
1 |
Microsoft Corporation
|
9.00% |
2 |
QUALCOMM Incorporated
|
6.66% |
3 |
eBay Inc. |
3.94% |
4 |
Intel Corporation
|
3.92% |
5 |
Cisco Systems, Inc.
|
3.80% |
6 |
Amgen Inc. |
2.91% |
7 |
Nextel Communications, Inc.
|
2.88% |
8 |
Dell Inc. |
2.84% |
9 |
Comcast Corporation
|
2.34% |
10 |
Starbucks Corporation
|
2.18% |
|
Total: |
40.47% |
Table 4 is breakdown the S&P 500
by Industry Groups.
Table 4:
Industry Groups (Source: Nasdaq.com) |
1 |
Computer & Office Equipment
|
27.02% |
2 |
Computer Software/Services
|
23.38% |
3 |
Telecommunications
|
14.39% |
4 |
Retail/Wholesale Trade
|
14.39% |
5 |
Biotechnology |
10.00% |
6 |
Health Care |
4.19% |
7 |
Services |
3.12% |
8 |
Manufacturing |
2.55% |
9 |
Transportation |
0.96% |
|
Total: |
100.00% |
Table 3 shows that the dominant
stock for the Nasdaq 100 is Microsoft. Chart 2 shows the impact of
Microsoft on the Nasdaq 100, tracked by the QQQs.
SPDRs and QQQs these can be
heavily influenced by the movements of certain stocks due to the
market capital weighted calculation.
The Rydex S&P Equal Weight ETF
Trust (Symbol: RSP) holds the same 500 stocks as the S&P 500, but
it is not a market capitalization-weighted index. It is an
unweighted version of the S&P 500 in which each of the 500 stocks
has a weighting of just 0.20. Therefore, no one stock or industry
has an unduly high influence on the performance of this exchange
traded fund. The smaller, far more growth oriented companies, can
therefore be more competitive on an economic basis. These smaller
companies will have the same influence on the performance of the
fund as the larger, less growth oriented companies.
The best way to show the
difference between the SPDRs, QQQs and the RSP is a relative
performance chart, as shown in chart 3.
Chart 3 shows the performance for
all three funds on a percentage change basis, with all three set
at zero on the first of the year. That the Rydex unweighted
version of the S&P 500 has significantly outperformed the other
two. This indicates that the broader market has been doing better
than the QQQs, which have been held back by semiconductor stocks,
or the SPDRs which have been hurt by insurance stocks, (AIG) and
healthcare stocks(Merc's troubles over the drug Vioxx).
Finally, what about volume? Over
the last 30 days the average daily volume for the RSP was 79,000
shares per day while the SPY was nearly 50 million and the QQQs
was over 100 million shares per day. Obviously, the RSP is a
vehicle for investors and traders who want an unbiased view of the
market rather than day traders.
Conclusion
The many new exchange traded fund
products available give traders and investors a host of
opportunities to take advantage of changes that impact the
economy, from rising oil prices to falling interest rates. In
addition, because the Rydex exchange traded fund is not unduly
influenced by the performance of a few large stocks or a
problematic industry, tracking it can provide significant insight
into developing market trends.
Thom Hartle is Editor of the Traders Expo Weekly. In addition,
he is contributing editor for Active Trader magazine as well as a
private trader. In a career spanning 25 years, he was editor of
Technical Analysis of Stock and Commodities magazine (1990-1999),
assistant investment officer and trader for the Federal Home Loan
Bank of Seattle (1985-1990), vice-president sales for Drexel
Burnham Lambert (1982-1985) and a commodity account executive for
Merrill Lynch (1979-1982).
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