One way you can improve your batting average as an investor is to look for bargain opportunities after the broad market has experienced a huge decline.
One of the most important ways of identifying strong buy candidates is to look for ETFs whose price lines have shown a clear and conspicuous divergence from the benchmark indices, such as the S&P 500 Index (SPX).
The key here is to look for signs that the seasoned market pros are accumulating (buying) stocks. In his book, The Secret of Selecting Stocks for Immediate and Substantial Gains, Larry Williams made this observation:
“To spot professional accumulation, all we need to do is find an example of steady and determined buying in the face of a weak stock market. When this happens, we have a good idea that professional buying is taking place.”
Another way of identifying how well an industry is performing versus the rest of the market is by using a relative performance (RP) line. This technique was developed many years ago by Carlton Lutts, founder of our Cabot Top Ten Trader momentum-investing advisory. He wrote:
“Relative performance (RP) is simply a measurement of how a stock is acting relative to the market as a whole. This can be measured mathematically, but we prefer a visual representation because we have found it easier to analyze. As they say, a picture is worth a thousand words.”
An RP line is basically the stock’s daily closing price divided by the daily closing price of the benchmark S&P 500 Index or another major index. It shows how the stock is behaving compared to the broad market, and as such, is a powerful tool that will give you a considerable advantage over the average investor. The RP line is simple to use; when it’s moving higher, it shows a stock is outperforming the broad stock market. When it’s declining, it shows the stock is underperforming. A steady, level RP line tells you the stock is performing roughly the same as the market.
By combining these two techniques, we now have two reliable ways of detecting accumulation (or informed buying) in an ETF:
- Look for a bullish divergence between the market itself—using the Dow 30 or S&P 500 as a benchmark—and the ETF you’re examining. For instance, when the S&P has made a series of lower lows over a certain time period, and the ETF you’re watching has made a series of higher lows in that same period, you’ve just found an ETF that is likely being accumulated by the “smart money” crowd.
- Watch for ETFs that are showing above-normal strength when compared to major indices like the S&P by using a relative performance line. You can easily spot an ETF’s relative performance by simply noticing if it has resisted declining in a period of broad market weakness. If it has shown strength compared to the S&P, it’s likely being held by “strong hands” or professionals. And it usually pays to follow the lead of the smart money crowd.
Let’s apply these basic principles to six of the most popular ETFs as we search for the best performers among them. For the rest of this article, below are the best ETFs in terms of relative performance (versus the S&P 500), starting with the lowest and working up to the highest ranking.
The 6 Best ETFs to Buy Now
6. Consumer staples typically perform well in a recession; after all, people will always need to buy things like shampoo, toothpaste and toilet paper. So, it’s not surprising that several well-known consumer staple firms have outperformed the averages of late. For that reason, the Consumer Staples Select Sector SPDR Fund (XLP) has outperformed the S&P 500 Index in recent months, as shown in the relative performance line below. The impressive rising trend in the fund’s RP line provides a strong indication that consumer staples have likely been accumulated by smart investors at a time when most participants were selling.
5. An even better example of an industry group with a strong RP line is internet providers. With millions stuck at home during the pandemic, the internet has become a service more essential than ever before. Consequently, the stocks of companies which provide internet-related services have been booming. This is illustrated by the strong relative performance of the First Trust Dow Jones Internet Index Fund (FDN) versus the S&P 500. With internet connection now a critical necessity for homebound workers, investors can likely expect to see continued growth ahead in this key industry.
4. Healthcare stocks have benefited from the market’s resurgence as investors focus their attention on healthcare providers, medical equipment makers and drug companies on the front lines of the fight against coronavirus. Coming in at number four on our list is the iShares Global Healthcare ETF (IXJ), which tracks the performance of several well-known companies in the healthcare sector, including Johnson & Johnson (JNJ), Bristol Myers Squibb (BMY), Abbott Laboratories (ABT), Pfizer (PFE) and others. Here you can see the eye-catching strength of IXJ in relation to the benchmark S&P 500.
3. Gaming stocks have also done exceptionally well during the coronavirus lockdowns as millions of people sitting at home, some with nothing much to do, are diverting themselves by playing video and online games. Last year, the ETFMG Video Game Tech ETF (GAMR) was created to track companies including video game software developers, publishers, platform providers and gaming accessories makers. The ETF has shown persistent strength when compared with the S&P lately, and with an uncertain timeframe for the end to shelter-at-home orders, gaming tech companies will likely continue beating the market averages for some time.
2. Gold has benefited tremendously from the flight-to-safety in the last few months as investors worry about the fragility of the global economy in the coronavirus’ wake. Many are also concerned that trillions of dollars recently created by central banks to prop up vulnerable markets could eventually lead to inflation. Consequently, investors have turned to gold and gold derivatives, including the stocks of companies that mine the precious metal. The VanEck Vectors Gold Miners ETF (GDX) is one of Wall Street’s star tracking funds right now and has completely outshone the benchmark SPX. GDX also has the distinction of being one of the only ETFs to have hit a new yearly high since the market crashed. This ETF holds several top gold stocks, including Newmont Mining (NEM) and Barrick Gold (GOLD).
1. Leading our list of the best ETFs during this period of uncertainty has been the Vanguard Extended Duration ETF (EDV). The ETF tracks the performance of zero-coupon extended duration Treasury securities and provides exposure to the red-hot Treasury bond market. T-bonds have obviously benefited from safety-related demand, and the following graph underscores the sizable performance gap between EDV and the S&P 500. EDV is one of the few actively traded funds near an all-time high and tops our list of outperforming ETFs in percentage gain terms.
Based strictly on relative performance, these are six of the best ETFs in the U.S. equity market right now. While past performance doesn’t guarantee future results, it usually pays to follow the path of the smart money traders and investors. And the ETFs discussed above appear to be among the favorites of this market-moving crowd.