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:
- 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.
- 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.
- 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.
- 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.
- 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.