Stock ETF Hurdles

Rate addiction is one of 5 things that could put a significant damper on stock market enthusiasm. Here is my list (in no particular order) of things that could sink U.S. stock ETFs:

  1. The “Tapering.” Many believe that our central bank is in the process of winding down its bond-buying program. That speculation led to a swift June sell-off in rate-sensitive assets like bonds and preferreds. More worrisome, the “3.4% Fixed for 30” is now “4.4% Fixed For 30.” Will investors or families be enthralled with 5.0%? 5.5%? 6.0%? Chances are, we’d see QE4 before that happens.
  2. Economic Growth or Stagnation? The media spin on the well-being of the overall U.S. economy is peculiar. Expectations of exceptionally low growth are routinely surpassed, exciting the investment community. The fact remains, though, that 1% average growth over the last 9 months is dismal. The stock market can ignore economic reality for long periods of time, though it cannot ignore ultra-slow growth indefinitely.
  3. Oil Prices Holding Above $100 Per Barrel. There are times when the stock market has moved in lock step with the direction of oil prices. “Pain at the pump” has often demonstrated a potential to send stocks plummeting. Not today, perhaps. What if $107 becomes $117? $127? The price of crude could serve as a rude awakening.
  4. Are European Banks Cruising For A Bruising? Political scares from Portugal to Italy to Greece continuously threaten the bailouts, aid and/or tenuous agreements that exist. If respective countries do not receive European Monetary Union help, scores of banks could be left overexposed to those country’s toxic debts. Moreover, the precedent-setting confiscation of deposits in Cyprus still could cause depositors to pull money out of other European banks.
  5. Overvalued and Overbought. There are plenty of reasons to be critical of stock valuation tools like the 10-year cyclically adjusted PE Ratio (a.k.a. PE10 or CAPE). That does not mean it is useless either. The 10-year price-to-earnings ratio for the S&P 500 stands at 25, not far from the 27 reached in October of 2007. This hardly constitutes a sell signal by itself, but it should be cause for reflection. In a similar vein, stocks gained ground on 19 out of the last 24 trading opportunities; similarly, the S&P 500 SPDR Trust is more than 10% above its 200-day moving average.

Naturally, I could have listed more reasons such as the upcoming debt ceiling debate or waning corporate sales. On the other hand, stop-limit loss orders and/or simple moving averages like the 200-day provide enough cover for reducing exposure to U.S. stock ETFs. The bigger question is what to do with additional cash. Rather than add more of the same, I am pursuing assets that have been less correlated with the U.S. stock market over the last 6 months.

For example, Vanguard FTSE All-World Excl U.S. Small Cap (VSS) has had a negligible correlation with the S&P 500 and with the Russell 2000 over the prior 6 months. By itself, it may appear vulnerable and volatile. In the context of a well-diversified portfolio, though, it may provide capital appreciation as well 4% annualized income. If purchasing the asset, be sure to understand under what conditions you might sell it.

Gary Gordon is president of Pacific Park Financial, Inc.