With the markets moving in lockstep, stock pickers may be out of luck. On the other hand, investors may better off riding out the higher correlation in equities with passive index-based exchange traded funds.
David Kostin, the Goldman Sachs’ U.S. equity strategist, warned that return dispersion, or the difference in returns between stocks, has declined following last month’s sudden sell-off, reports Julie Verhage for Bloomberg.
Moreover, Kostin pointed out that falling dispersion and an equity sell-off rarely occur simultaneously. Since 1981, the two coincided only twice during Black Monday in 1987 and in the latter stages of the tech bubble.
Consequently, Kostin argues that the markets will move less on individual company fundamentals but on more macroeconomic events instead, so 2015 will be another tough year for traders seeking alpha, or outperformance.
“We ultimately expect dispersion to remain low during the next several quarters, owing to our economists’ forecast for sustained economic growth,” according to Goldman Sachs’ analysts. “During periods of economic strength, most S&P 500 firms generate solid sales and earnings growth, diminishing performance differentials among stocks. In contrast, during periods of weak growth, return dispersion increases as the market becomes increasingly discerning over which companies are best positioned to weather economic downturns.”
ETF investors who want to track the broad markets have many options to choose from. For instance, the SPDR Dow Jones Industrial Average ETF (NYSEArca: DIA) follows the Dow Jones Industrial Average Index, SPDR S&P 500 ETF (NYSEArca: SPY) tracks the S&P 500 Index and PowerShares QQQ (NasdaqGM: QQQ) follows the Nasdaq-100.
If your goal is to just passively track the broad U.S. markets as closely as possible, one might consider cheap U.S. stock ETFs. For example, the Vanguard Total Stock Market ETF (NYSEArca: VTI), with a 0.05% expense ratio, and the Schwab U.S. Broad Market ETF (NYSEArca: SCHB), with a 0.04% expense ratio, are among the cheapest U.S.-listed ETFs that provide exposure to nearly the entire U.S. stock market. [Build a Dirt-Cheap Portfolio With These ETFs]
VTI tracks the CRSP U.S. Total Market Index, which includes almost every liquid U.S. stock on the market. [The Total Cost of Investing in ETFs]
SCHB, on the other hand, follows the Dow Jones U.S. Broad Stock Market Index, which includes about 95% of the U.S. equity market. However, SCHB does not have exposure to micro-caps, which VTI does.
For more information on index funds, visit our indexing category.
Max Chen contributed to this article.