Recap of 2010 Market Performance & ETF Tracking Error

Monday, January 03, 2011

After a couple weeks off from posting through Christmas and the end of the year, I'm back to recap the year. Santa Claus showed up at the end of 2010 to add to the gains while the economic calendar and geopolitical environment presented no impactful news to derail the advance. The primary US index, the S&P 500, mounted a solid 13% advance for 2010 closing a volatile year that included a 17.1% correction from high to low mid-year. The last four months of the year alone offered a 19.85% return as fears of a double dip recession and a meltdown in Europe abated and stocks recouped the drawdown.

I have had many conversations recently about the advantages and disadvantages of ETFs so I thought it would be worthwhile not only to look back at last year's performance in various markets but to compare these markets to their primary respective ETFs. I am wholly convinced that ETFs are the best bet for the vast majority of investors who control their own accounts, easily topping individual stock-picking and mutual funds.

Market Benchmark
ETF Benchmark
ETF Tracking
Dow Jones$DJIDIA11.02%11.11%(0.09%)
S&P 500SPXSPY12.78%12.84%(0.06%)
Nasdaq 100NDXQQQQ19.22%19.04%0.18%
Russell 2000RUTIWM25.31%25.30%0.01%
Crude Oil/CLUSO15.17%(0.71%)15.88%
Natural Gas/NGUNG(21.18%)(40.58%)19.40%
US Dollar$DXYUUP1.42%(1.60%)3.02%
Data based on thinkorswim closing prices.

The equity market ETFs do an excellent job of tracking their benchmarks with the SPY and DIA actually outperforming marginally after fees during the year. As has been reported across the financial world, the commodity ETFs that trade in futures contracts, JJC, USO and UNG, have large tracking errors. These ETFs are crushed by the rollover costs associated with contango, a concept far too many retail investors do not understand. GLD, which holds the physical metal, must only pay storage costs. It is not surprising then to learn that a new ETF backed by the physical metal for copper will debut in 2011 but will carry a hefty storage fee of 1.5% as copper's equivalent weight to gold results in much larger volume.

I think copper and crude oil are best used as indicators for equity markets. The relevant ETFs are garbage and without a substantial education in futures trading, these markets are simply out-of-reach for most non-professionals. Equity ETFs, on the other hand, are excellent vehicles for achieving low-cost diversification. While investors may be giving up some of their opportunity to achieve alpha it is often best to accept beta and to just worry about the front-end of consistently depositing money into the account. Yet, the game is fun, that's for sure, and active investors can always put most money aside and play with the rest in search of alpha.

Overall, the economy is improving, companies are making more money and stocks are pushing higher. The elephant in the room is clearly the US jobs picture which will likely improve in 2011 as productivity growth slows and firms look to improve the top line by hiring. Here's to a prosperous 2011!

Brandon R. Rowley
"Chance favors the prepared mind."

*DISCLOSURE: No relevant position
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