Simple strategies are memorable. Nonetheless, investors are often misinformed about how strategies came about and how they are supposed to be used. In the investing world, there are those who buy outperforming companies — trend following — and those who would get into underperforming ones — mean-reversion. The key is to understand what is driving the outperformance and underperformance.
The chart above shows the large underperformance of the Guggenheim Shipping ETF (SEA) compared to a popular Chinese ETF iShares FTSE/Xinhua China 25 Index (FXI). It is widely known that the industrial sector is highly sensitive to economic activity and the stock market. The industrial sector tends to outperform when the market rises and underperform when the market falls. However, that has not been the case over the past six months.
While the market is not always accurate, the Guggenheim Shipping ETF (SEA)’s underperformance suggests negative fundamentals are putting pressure on the shipping industry’s revenue and earnings. Even though China’s recent announcement of a stimulus package on infrastructure investment should directly benefit shipping companies through an increase in raw material imports, industry supply fundamentals such as excess ship orders may be limiting the upside.1
Investors who have gotten into the shipping industry based on mean reversion strategy may see positive returns: when the market goes up, most industries will rise. However, until supply fundamentals, a key driver that has led to the shipping industry’s underperformance, turn positive, the shipping industry will likely continue to lag. In the short to medium term, this will negatively affect shipping companies such as DryShips, Inc. (DRYS), Diana Shipping, Inc. (DSX) and Eagle Bulk Shipping, Inc. (EGLE).