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How Accurate a Picture Do ETFs Paint of the Sectors They Represent?


The exchange traded fund XRT, for example, portrays the health of consumers in a negative light, but that's not necessarily accurate.

With the widespread acceptance of exchange traded funds (ETFs), commentators, investors, and traders are drawing conclusions that are not supported by the facts. This can be harmful to your financial health.

The SPDR S&P Retail ETF (NYSEARCA:XRT) for example, portrays a very sick picture of consumer health. Since the consumer represents two-thrids of GDP, if you were to look at just this ETF, the conclusion would have to be that the economy is struggling. But is that an accurate assessment?

Source: Technical Analysis Today

To truly answer that question, you have to look deeper to understand what is in the ETF. What does it really represent?

A quick look at the fact sheet shows that the majority of the ETF is comprised of apparel and specialty stores like eateries, pawn shops, etc. With roughly 50% of the ETF focused on just two industry groups, the focus on smaller capitalization stocks, and the Internet being a minority of the holdings, is this ETF really representative of all retail anymore?

Source: State Street Global Advisors

An alternative ETF that is also widely traded is concentrated in large capitalization stocks and has a greater focus on media instead of apparel but is also more heavily weighted (concentrated) in the top holdings, is the Consumer Discret Select Sector SPDR (NYSEARCA:XLY) where the picture looks quite different.

Source: www.tatoday.comSource: Technical Analysis Today

Again, the Internet industry group garners about the same representation percentage, so the main difference is media as the primary industry group and the allocation weightings of the stocks that comprise this ETF (not shown).

Source: State Street Global Advisors

With a plethora of ETFs at your disposal, it is easy to look at the performance of this or that ETF and draw conclusions that may or may not be reasonable or appropriate. So which is right? And do neither give us a complete picture of the health of the consumer?

It would seem that XLY is a better representation, though not perfect. If you combine these two charts, then clearly retail is struggling as compared to, say, the technology or financial sectors where, no matter which ETF you look at, they are uniformly strong. But to look at XRT and conclude that the consumer is dead, is itself an overstatement and inaccurate. Apparel is clearly troubled, but little more can be said. If you were to do anything with the knowledge these charts provide, you would concentrate on shorting the weak one (XRT) and buying the strong ones, such as the Technology SPDR ETF (NYSEARCA:XLK) (see chart) and the Financial Select Sector SPDR ETF (NYSEARCA:XLF) (see chart).

Editor's note: L.A. Little is a professional trader, author, and money manager who has written several books and contributed material to many financial sites in addition to authoring his own: Technical Analysis Today. He brings a unique perspective to technical analysis, incorporating his extensive engineering and modeling skills when analyzing the markets.

Twitter: @tatoday
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