How to Use Sector ETFs to Create a Diversified Stock Portfolio

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The highly correlated sector ETFs -- XLB, XLF, XLI, XLK, XLV and XLY -- would make the portfolio an undiversified and aggressive one, while the addition of XLP (less correlated), GDX (uncorrelated) and XLE (negatively correlated) would help reduce risk and make it a more diversified one. 

The graph demonstrates, while XLK and XLP moved in tandem initially, they significantly diverged later in the year, suggesting that the longer holding period is equally important in reaping the true benefits of diversification.

Ideally, in order to capture any meaningful shifts in ETF relationships, researchers should run this matrix in three phases: short-term (recent 30 days), medium-term (6 months) and long-term (9-12 months). 

Data - The above matrix is compiled off of the closing prices between 01-03-17 and 10-25-17.

Disclaimer - The author is not advocating any of the ETFs listed here; instead, this is promoted an alternative research in diversifying an equity portfolio, leading to a better asset allocation model. 

Consult your Registered Rep, RIA or Financial Planner for an appropriate asset allocation model and the potential holdings therein.  

--Sid Som

sidsom1@gmail.com

Understanding the Missing Link between Fundamental and Technical Equity Analysis -- A Meaningful Correlation Matrix

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Analysis of the above Correlation Matrix

1. The correlation among Apple (AAPL), Amazon (AMZN), Facebook (FB) and Google (GOOG) is very (positively) high (> 0.80), meaning they will move in tandem. A portfolio comprising exclusively of such highly correlated stocks would be considered an 'Ultra Aggressive' portfolio.

2. Twitter (TWTR) however adds a low-to-moderate positive correlation to the aforesaid four, meaning there are days TWTR will not necessarily move in lockstep with the other four stocks. A portfolio constructed as such would, nonetheless, be 'Very Aggressive.'

3. IBM, on the other hand, shows negative correlations with all five and obviously very high correlations with the first four, thus providing an excellent hedge. The inclusion of the IBM hedge would lower the overall risk, paving the way for an 'Aggressive' portfolio.

Ideally, in order to capture any meaningful shifts in relationships, researchers should run this matrix in three phases: short-term (recent 30 days), medium-term (6 months) and long-term (9-12 months). 

Data - The above matrix is compiled off of the closing prices between 01-03-17 and 10-23-17.

Disclaimer - The author is not advocating any of the stocks listed here; instead, this is just a research piece  - often overlooked - connecting fundamental and technical analyses. Consult your Registered Rep, RIA or Financial Planner for an appropriate asset allocation model and the potential holdings therein.  

--Sid Som
sidsom1@gmail.com