Hedging Energy, Telecom, and Bonds via ETFs with Negative Correlations

Smartmoney.com is offering free use of their Correlation Tracker for a limited time as a promotion, and I used it to check whether I am doing enough to hedge major portfolio positions in energy, telecommunications, and bonds.

Enter a ticker symbol and the correlation tracker will list the ten ETFs and ten stocks which have the highest and lowest correlation to that security over various time frames from six months to three years. I found it helpful to look for patterns, instead of focusing on individual securities, and to look for issues and sectors that appear in more than one time frame.

I used XOM, a major portfolio holding, as a proxy for energy, and found that the following sectors and representative ETFs have a strong negative correlation: Bonds (LQD); Pharmaceuticals (XPH); European stocks (IEV); DJ Transports (IYT); Internet (FDN); Banks (KBE); Homebuilders (XHB); and PowerShares WilderHill Clean Energy (PBW). This confirms my intuitive analysis in most cases, but it had not occurred to me that the Dow Jones Transports (IYT) would tend to move oppositely to XOM, although on reflection, it is obvious; and I have been avoiding PowerShares WilderHill Clean Energy Portfolio (PBW) because I thought it would be highly correlated with the energy sector.

Next, I used IYZ as a proxy for the telecommunications sector, and found that Internet stocks (HHH), Short-term and inlation-protected bonds (SHY, TIP) and Oil and Commodities (USO, OIH, DBC) exhibit negative correlation. No surprises there.

Finally, I checked the investment grade bond sector as represented by LQD. As expected, Foreign stocks (ITF, EWU, EWA, FXI), Industrials (XLI, VIS), Gold and Natural Resources (GLD, IAU, IGE), and Energy (USO, OIH, IXC) all exhibit negative correlation to bonds. But I was surprised to see that the iShares Dow Jones Transportation Average (IYT) shows up here too.

I’ve never given much thought to the Dow Jones Transports, and I discovered they have handily outperformed the S&P500 for most of the last three years. IYT could be a successful investment in its own right, in addition to serving as a hedge for bonds and energy stocks. However, you won’t get rich on IYT’s dividend yield of .56%, and its beta is a rather high 1.25. The fund’s expense ratio is .60 which also seems rather high, in view of the simplicity of tracking an index with only 20 components.

Nevertheless, I see IYT as a “must have” for the portfolio and will start looking for a good entry point.

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2 Responses to “Hedging Energy, Telecom, and Bonds via ETFs with Negative Correlations”

  1. umagumm Says:

    (From a recent Barron’s)
    “Airline stocks are entering a strong seasonal period. From Oct. 1 to June 30, the shares, as measured by the XAL, have beaten the S&P 500 Index in eight of the past 10 years-and by an average of nine percentage points. Starting on Oct. 1, 2005, the XAL rose 29% in the ensuing nine months, versus a 3.4% rise for the”S&P. Historical patterns, obviously, are no guarantee of future performance, but the strong season coincides with stock valuations that look reasonable.”

  2. Alligator Investor Says:

    Good info – thanks.

    Studying the chart of IYT, it looks as though money has been flowing in since the beginning of the quarter, perhaps in response to this article, and in anticipation of the seasonal tendency.

    IYT looks a little overbought right now and I don’t think they would like it if any more planes crashed in Manhattan 😉

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