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Friday, October 5, 2012 - 16:00
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Friday, October 5, 2012 - 17:11
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Friday, October 5, 2012 - 16:00

Bank an 11% Yield on an ETF That's Outperforming 96% of the Market

Friday, October 05, 2012 4:00 PM

Many analysts on CNBC wonder what the Federal Reserve will do next, even though it has already clearly told us it will continue with a quantitative easing policy for years to come. In official policy statements, the Fed has vowed to keep interest rates low (near 0% for short-term loans) until at least 2015, and continue buying at least $40 billion a month of mortgage-backed securities indefinitely.

Rather than trying to guess what the Fed will do next, as investors, we can look to see how a simple trading strategy would take advantage of the Fed's decisions. If the system has done well, then we can then follow its future signals that are likely to profit no matter what the Fed does.

My 26-week rate of change (ROC) system was already in the right market when the Fed announced its third round of quantitative easing program (QE3). The system rules said to buy iShares FTSE NAREIT Mortgage Plus (NYSE: REM) on May 25, more than three months before the Fed acted. This is exactly what we'd like to see happen in this system.

Ideally, this system buys the right sector or markets before the announcement of big news. While the specific details of QE3 were a surprise, it was widely anticipated that the Fed would be buying mortgage-backed securities.

Major Wall Street firms and hedge funds would likely be buyers ahead of the news, and their buying should be detected as high relative strength (RS) in that market compared to other investment options. That's exactly what happened in REM. Large buying made this the strongest exchange-traded fund in the alternative investment asset class and helped us buy into the sector ahead of the news.

Including the dividends received since buying REM, investors are up 14.5% on that position, easily beating the S&P 500 Index in a strong stock market. SPDR S&P 500 ETF (NYSE: SPY) is up almost 11% during that same period, also factoring in the dividends paid. This performance highlights the fact that, in short-term up moves, the highest RS ETFs should be able to outperform the market.

The chart below shows that there could be more gains ahead in REM.

RS is still high with a rank of 96, indicating that REM is among the top 4% of market performers. The price pattern indicates that a move to $17.82 is possible based on a bottoming pattern that has formed on the chart during the past year. This price move would provide gains of an additional 17.6%, and the double-digit dividend yield, currently at more than 11%, would add to those gains.

There is also a very strong fundamental reason to expect more gains from REM. Goldman Sachs estimated that Fed mortgage-buying could top $2 trillion by the time the bank is done with the program. This would represent a significant amount of demand in a market that is estimated to total only $7 trillion. The Fed demand could continue driving up the prices of these securities -- including REM -- for several years.

Action to Take -- > The ROC system is maintaining a "buy" in REM, and that adds to the perception that this seems like a safe trade in a risky market. The 11% dividend yield on the ETF offers income in a market with low interest rates, which the Fed guarantees to stay low for years. If you have not already done so, then consider adding REM to your portfolio as an income position.

There are no changes to the model portfolio this week. It continues to hold:

This article originally appeared on TradingAuthority.com:

Bank an 11% Yield on an ETF That's Outperforming 96% of the Market

Michael J. Carr does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.