Contrarian ETF Ideas: Investing In The ETF Dogs Of 2011

by on October 11, 2011 | ETFs Mentioned:

With three quarters of 2011 officially in the books, it is now safe to say that the year has not played out as many investors had hoped it might. After coming flying out of the gates–most major benchmarks were solidly in positive territory after the first quarter–a perfect storm of negative developments has conspired to hammer valuations of risky assets, leaving many portfolios drenched in red ink. Most equity indexes are down considerably in 2011, with many recently testing new lows on renewed concerns about debt woes in Europe and the frustrating lack of job creation in the U.S.

While the vast majority of equity ETFs are now deep in negative territory for the year, some have, of course, been hit harder than others. A handful of funds have piled up year-to-date losses that exceed 35%, with several losing almost half of their value since the start of the year. For those with positions in these products, the abysmal performance can of course be frustrating. But for those with capital waiting to be deployed, a review of the dogs of 2011 can perhaps generate some intriguing opportunities.

It’s worth noting that recent history suggests that these laggards might have potential to soar if markets have indeed bottomed out, as some technical traders believe is now the case. When markets turned in March 2009 and headed sharply higher, the products that were hammered the hardest on the way down enjoyed the greatest surges on the up side.

Ticker ETF YTD Loss*
URA Uranium ETF -59.8%
KWT Solar Energy ETF -57.0%
SEA Shipping ETF -49.1%
CHIM China Materials ETF -45.3%
EGPT Egypt ETF -45.2%
ECNS China Small Cap Index Fund -41.2%
PKOL Global Coal Portfolio -35.2%
*As of 10/10/11

iShares MSCI China Small Cap Index Fund (ECNS): Down 41.2%

Behind The Freefall: Chinese stocks have been hammered so far in 2011; at the end of September, the best performer in the China Equities ETFdb Category had lost about a quarter of its value. Concerns about inflation have weighed on this emerging market as has anxiety over Beijing’s currency policy. After outperforming their large cap counterparts for the better part of the last two years, small caps have fallen back in 2011–China serves as an excellent example of that phenomenon.

Likelihood of Rebound: Strong. In the short term, China certainly faces a number of challenges. The country is not immune from slowdowns in Europe and other developed markets, and lingering inflationary pressures have created unique challenges for the government there. But over the longer term, the past few months have done little to diminish the tremendous potential of the Chinese market [also read ETF Research Report Now Available: China ETFs In Focus]. The favorable demographic trends remain in place, with cities continuing to grow at a tremendous pace and discretionary income continuing to climb.

The sell-off in ECNS so far in 2011 has seemingly created an opportunity to buy into an asset class with a very bright future at a steep discount. Even if more volatility is ahead in the short term, this ETF seems to be positioned for strong long-term gains [see BRIC ETF Investing: Small Cap Edition].

Global X Uranium ETF (URA): Down 59.8%

Behind The Freefall: The nuclear power sector melted down along with the reactor in Japan in the aftermath of the devastating earthquake there earlier this year. After witnessing the fallout, several countries stated their intentions to drastically scale back nuclear power expansion plans, bowing to public pressure and dealing a severe blow to a still young industry that was seemingly poised for tremendous growth.

Likelihood of Rebound: Strong. The uranium industry is tied closely to the success of nuclear power, which has been dealt a series of setbacks in 2011. But this space still seems to maintain an overwhelmingly bright future, as a handful of nations have plans to drastically scale up nuclear power output in coming years. As the Japan disaster gets further and further in the rear view mirror, the political viability of nuclear power increases substantially [see Nuclear ETF Meltdown: Four Funds Rocked By The Japanese Quake].

Given the tremendous cost advantages over other forms of alternative energy, nuclear power seems to be a clear favorite in an environment where many countries are strapped for cash. And the significant advantages over more traditional energy sources remain; nuclear power is a cheap, efficient, and relatively safe source of power. Again, URA seems to have been punished too severely, resulting in an attractive price for a long-term asset.

Egypt Index ETF (EGPT): Down 45.2%

Behind The Freefall: Egypt has endured tremendous ups and downs throughout 2011, beginning with the overthrow of the government earlier this year. After the country’s stock market was closed for several weeks, EGPT tumbled as investors sold off stocks in anticipation of a prolonged transitional period. Shortly after trading in Egypt resumed, global equity markets began their slide lower, piling larger losses up on this fund.

Likelihood of Rebound: Moderate. The transition to a post-Mubarak Egypt has been anything but smooth, as violence continues to plague the north African country.

Over the long run, the transition to a more open and modern economy should obviously benefit Egyptian companies, which will gain access to new markets and avoid the crippling corruption that was characteristic of the past administration. But it wouldn’t be surprising if more pain is in store in the short term, as Egypt faces a number substantial hurdles to sustainable economic growth. The long-term outlook for this country may be bright, but EGPT’s recovery to pre-revolution highs in far from certain [see Egypt ETF: Back To Normal].

Global Coal Portfolio (PKOL): Down 35.2%

Behind The Freefall: The coal industry has been on a wild ride over the past few years; coal ETFs were hammered during the 2008 recession, only to see a huge bounce once markets finally bottomed out. So far, 2011 has been a repeat of 2008, as both PKOL and the Market Vectors Coal ETF (KOL) have fallen sharply lower.

Though movements to cleaner sources of energy are underway, coal remains a dominant fuel source in much of the world–particularly in rapidly-expanding China. Coal companies often serve as leveraged plays on the broad global economy, a relationship that has certainly played out in 2011 as stocks have moved broadly lower [Mining ETFs: Eight Ways To Play].

Likelihood of Rebound: Moderate. The coal industry’s future is uncertain, but the cash flow woes of governments that have been leading the push for alternative fuel sources would seem to extend the window of this fuel as a widely used energy source. Expect coal to continue to function as a leveraged play on the global economy going forward; if stocks recover, this ETF could be one of the biggest gainers in the fourth quarter. If the free fall continues, there is certainly more room for PKOL to fall.

Shipping ETF (SEA): Down 49.1%

Behind The Freefall: The dramatic sell-off in shipping stocks has come as concerns about the health of the global economy drove investors out of assets that rely on transportation of goods. With companies around the back scaling back expenses, transportation revenues have quickly dried up in a soft market.

SEA’s struggles have also been driven in part by a hefty allocation to Greek stocks. With about 10% of its portfolio dedicated to the country, SEA has a bigger allocation to Greece than any other equity ETF [see ETFs With Greece exposure].

Likelihood of Rebound: Moderate. Similar to coal products, it is reasonable to expect the shipping industry to function as a leveraged play on the global economy. If confidence rebounds and stocks regain their footing, SEA could be a primary beneficiary as the “worst case” scenario improves considerably.

Global X China Materials ETF (CHIM): Down 45.3%

Behind The Freefall: The inclusion of another China ETF on this list underscores just how quickly demand for stocks in the world’s second largest economy has deteriorated this year. CHIM has been hit by the double whammy of a struggling Chinese market with a recent slide in commodity prices, which has eaten into the profitability of materials companies.

Likelihood of Rebound: Strong. Again, the demographic trends playing out in China are too significant to ignore, and the rapid rise of urban areas figures to create demand for raw materials for decades to come [see more on CHIM's Fact Sheet].

Market Vectors Solar Energy ETF (KWT): Down 57.0%

Behind The Freefall: Alternative energy ETFs have been hammered throughout 2011, as fiscal concerns throughout the developed world have prompted governments to scale back or eliminate generous subsidies on which the still young industries continued to rely. Solar ETFs have been among the biggest dogs, however, as a high profile implosion in the U.S. highlighted the tremendous challenges this industry faces to becoming economically viable [see Sunny Days Ahead For Solar ETFs?].

Likelihood of Rebound: Low to Moderate. While the huge decline in KWT’s value in 2011 may attract contrarian investors, the fundamentals in this corner of the market aren’t quite as strong as some of the other dogs of 2011. The massive subsidies heaped on the solar industry seem to be a thing of the past given the unstable fiscal footing throughout Europe, and the long-term viability of solar power is no longer certain given more impressive advances in other corners of the alternative energy market. KWT could be only partway through a long, slow decline that ends up burning investors.

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Disclosure: No positions at time of writing.