David Kotok of Cumberland Advisors is one of the most
established ETF-focused financial advisors in the world. With
$1.9 billion in assets under management and a 39-year track
record, Cumberland has been a leader in the independent,
fee-for-service money management business through multiple booms,
busts and fads.
Kotok recently published a book-"From Bear to Bull With
ETFs"-explaining how he uses sector-based ETFs to invest during
both boom and bust cycles in the market. IndexUniverse's Global
Head of Editorial, Matt Hougan, who wrote the foreword to the
book, caught up with Kotok recently to discuss the book and his
outlook for the market today.
You recently wrote a book on sector investing with ETFs. Why are
sectors a useful way to approach the market?
The benchmark for the U.S. stock market is the S&P 500 Index.
It is composed of sectors and they are key to gaining performance.
The ETF choices among the sectors facilitate this process. Choosing
a sector to overweight or underweight requires macro inputs and a
rationale for the decision. This is coupled with selection of
broader characteristics such as growth vs. value or large-cap vs.
small-cap. In some cases, you can combine them.
Which two U.S. sectors look the most attractive to you right now
and how are you investing in them with ETFs?
We like the health care sector. The broad-based ETF is XLV [the
Select Sector SPDRs - Healthcare (NYSEArca:XLV)], and we hold
This sector has been maligned for years. Prices of the stocks
were depressed because of fear of government intervention in the
industry and imposition of price controls. We think all the bad
news is known and the stock prices reflect the worst-case outcomes.
Meanwhile, the health care industry, in the broadest sense, is 17
percent of the U.S. GDP and growing. The growth is unstoppable
since we have a more affluent, aging population. Thus, the ETFs are
In addition to XLV, we like the health care equipment companies.
They are more resistant to government intervention, which tends to
focus more on the drugs than on mechanical devices or passive
equipment. Thus, we like IHI, the iShares ETF [iShares Dow
Jones U.S. Medical Devices ETF (NYSEArca:IHI)]. An additional
way to play the health care sector is in the smaller-cap growth
companies. PowerShares has a small-cap health care ETF that has
characteristics that delve into the growth possibilities. Our
choice ETF in this space is PSCH [the PowerShares S&P SmallCap
Health Care Portfolio (NYSEArca:PSCH)].
Which U.S. sectors looks the least appealing to you right now, and
The telecommunications sector and the utilities sectors are out of
favor. They are usually defensive plays and this market is looking
for growth, not defense. We have sold our positions in these two
sectors. We previously owned XLU [the Select Sector SPDR -
Utilities (NYSEArca:XLU)] and the iShares Dow Jones US Telecom ETF
Are sectors global? Does it make more sense to buy a "global
Financials" ETF instead of a "U.S. Financials" ETF, or do
country-specific sectors still matter?
Global influences are large. This is especially true in industry
groups where the heavy share of profits is earned abroad. Intel is
in the tech sector; it earns large portions of its profits from
foreign sources. Pharma companies like Pfizer do the same. So does
Coca-Cola. Therefore, when you buy a sector or industry ETF where
these are large weights, you are investing globally and in baskets
of companies with global exposure.
Likewise, a commodity-oriented ETF functions in a similar way.
XLE [the Select Sector SPDR - Energy] is the basic energy sector
ETF. Its heaviest weight is Exxon and Chevron, both massive global
companies. Other ways to play in this sector are IEZ [the iShares
Dow Jones US Oil Equipment & Services (NYSEArca:IEZ)], which
involves oil services. IEX and XES [the SPDR S&P Oil & Gas
Equipment & Services ETF (NYSEArca:XES)] get you deeper into
drilling and equipment. A mix of these allows the investor to alter
the overall weight and emphasize drilling and exploration, and
lessens exposure to refining and downstream marketing. Rebalancing
can allow this position to be reversed while remaining in the
energy sector for an overall portfolio weight.
What is your outlook on global equity markets for the remainder of
the year? What are the biggest risks to the market's recent strong
The bull market started on Oct. 3, 2011. I discussed it in detail
in my book. The market is following a pathway similar to other bull
markets that occurred after a nonrecession bear market. We had a
nonrecession bear market from April 29, 2011 to Oct. 3. If we track
the median outcome of the past World War II periods, this bull
market is only half over. It could take another 10 to 30 months to
gain the other half.
Of course, there are many outside influences that could alter
this forecast. The Fed is unlikely to move off the zero
interest rate boundary in 2012. However, it could, and that would
be a game-changing event. Markets are also focused on Europe and
the workout there is not complete by any means. Spain is the latest
poster child of a troubled debt problem. Italy and Portugal are
also in that limelight. In southern Europe, the economies are
shrinking, not growing. When there is not growth, the debt burdens
become increasingly harsh. The debt burdens are now the source of
I could go on and list risks for hours. The issue at hand is if
the U.S.-focused investor wants to bet on the risk outcome or wants
to favor a position that reflects ongoing slow but gradually
improving U.S. economics. I choose the latter.
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