STA Weekly Report – Some Positive Market Developments
INSIDE THIS EDITION:
Some Positive Market Developments
ETF’s: Liquidity, Asset Growth, Reduced Fees, and a Warning
Weekly Technical Comment
Roth IRA Conversions – New Tax Smart Strategies for 2018
401k Plan Manager
It was another positive week for stocks. The large-cap S&P 500 advanced almost 0.6% while the smaller issues of the Russell 2000 gained nearly 0.4%. The advance was led by Technology and Basic Materials (both gaining over 1%) while Non-Cyclical issues fell more than 2%.
The market recently went through its first correction (a decline of 10% or more) in some time. It has been rebounding and many are wondering what course of action they should take.
A good place to start looking for answers is history. At major market tops we have often seen an initial move downward (since 1960 this first decline averages 11%). After this move, there is often a rebound averaging 7%, which usually lasts about a month. Finally, there is another major leg downward that pushes prices lower, on average, 28%. This phase lasts around 250 days. A normal correction on the other hand is less violent and actually provides an earlier return to buying opportunities.
Discerning whether the current environment is a bear market or a normal correction can be tricky. One helpful method is to rely on a series factors that include economic, fundamental and technical indicators. Our indicators have provided excellent clues as we have managed client wealth and provided guidance to others.
What else? We would have to say that we have experienced some positive market developments and earnings guidance has been uniformly positive. From the turn of the year to mid-February, 127 S&P 500 companies have raised guidance for 2018 – the average for the past decade over comparable timeframes is 49. The big gap is premised on tax cuts hitting the bottom line. This is constructive. It is also constructive with 90% of the S&P 500 companies having reported Q4 financial results, that 77% beat (the norm is 64%) and just 15% disappointed (the average is closer to 21%). We are now seeing Q4 earnings per share come in 15% higher than a year-ago levels for the third quarter in a row of double digit gains.
From a strategic standpoint there are still risks; namely expensive valuations, changing monetary policy, and excessive optimism. These will need to be dealt with eventually, perhaps later in the year. While we would avoid aggressiveness in stocks, our indicators no longer suggest taking excessive caution.
Recent volatility in the equity markets served as another test of how ETF’s might react to heightened levels of volatility. Except for a few esoteric products linked to volatility derivatives, ETF’s performed without issue during the market selloff that lasted from February 5th until February 11th. In many ways, this is a major relief for investors and traders who have increasingly used ETF’s not only to gain their equity exposure, but also as a source of liquidity during times of market stress.
During the most volatile days, liquidity is of utmost importance to investors as they look to de-risk their portfolios. As the chart below illustrates, February saw a brief spike in ETF daily average trade volume to more than $200 billion, a sign that investors increasingly relied on ETF’s to reduce or change their equity exposure in response to rapidly changing market conditions.
This seems to align with what we have historically seen during previous bouts of market stress – ETFs see their heaviest trading when markets are in freefall. During 2008, for example, $25 trillion worth of ETF’s traded, making it the most active trading year for ETF’s in history. For comparison, 2017 had only $18 trillion dollars in ETF trading volume even though ETF assets had grown 7-fold.
With increased trading volume, ETF sponsors have been able to introduce new products and attract even more assets as investors seek out highly liquid investment vehicles, especially when markets are less stable.
During early February, more than 20 ETF’s saw their 30-day average volume grow to more than triple their average 180-day trading volume. While a portion of the 20+ ETF’s that experienced an explosion in trading volume were short-term trading vehicles that employ leverage, several were more traditional low-cost ETF products. Some of these traditional low-cost ETF’s on the list recently saw a fee reduction that could have explained some of the increased trading volume. For example, the SPDR Portfolio S&P 500 Growth ETF and SPDR Portfolio S&P 500 Value ETF each saw a 1bp fee reduction in October and saw among the highest inflows during the recent selloff.
In fact, SPDR products as a group, saw a $10 billion increase in assets during the selloff. While liquidity was certainly one driver of the increase in assets, the other driver was the reduced fees as ETF investors are extremely sensitive to fee changes. To provide a sense of just how sensitive investors are to lower fees, we can look to a group of SPDR ETF’s in the table below and the growth in assets following the announcement of lower fees.
While we believe that lower fees are an important component of the due diligence and selection process for ETF’s in a portfolio, we must stress that it should not be the only consideration. Unfortunately, some investors overlook this to their own detriment and leave themselves susceptible to tax complications or take on undue risk.
Take for example the SPDR Gold Trust, one of the most popular ways to get exposure to the gold market. While it has a relatively low expense ratio of 0.40%, investors could face a tax complication due to its structure as a grantor trust. Grantor trust holdings are typically considered collectibles by the IRS, an asset that will be subject to higher taxes than traditional securities. Most investors are unaware of this tax treatment so are surprised when they see long-term gains for GLD taxed at 28%.
This should serve as a warning that not all ETF’s are created equal. While ETF’s have grown in popularity during times of market volatility and can offer both high liquidity and low fee investment options, working with an advisor that conducts deep due diligence on ETF’s before adding them to a portfolio is extremely important. For this reason, it is crucial to get familiar with the differences between investment vehicles as selecting the right vehicle to invest in can drastically improve investment outcomes over time.
S&P 500 Index Gains More Ground, But…
The S&P 500 Index gains more ground, but the index is looking overbought according to our technical indicators and due for a pullback. U.S. stock indexes continue to gain more ground today and have now regained about three-quarters of their recent correction.
Chart 1 and 2 show the Dow Industrials and S&P 500 trading at three-week highs after clearing their 20- and 50-day moving averages. The 14-hour RSI line (top of chart) has reached overbought territory at 70 for the second time since the recent rebound began (down arrows). That’s usually when rallies start to experience some selling. A positive divergence in the RSI line a couple of weeks ago helped start the stock rally (green arrow). In addition, the hourly MACD lines (below chart) are also showing a slight negative divergence (declining trendline). With the S&P 500 having regained more than two-thirds of its recent correction, a pullback from here wouldn’t be too surprising. If one does occur, the green Fibonacci lines show potential underlying support levels ranging from 2700 to 2640. A pullback into that support range would be relatively normal and would keep stocks in a sideways consolidation pattern between their January highs and February lows.
NASDAQ 100 (Powershares QQQ) Is Meeting Resistance
Chart 3 shows the PowerShares QQQ (tracking the NASDAQ 100 Index) nearing a challenge of its late-January intra-day peak at 170.95 and meeting resistance. Since the QQQ has been leading the market higher, that could be an important test. The volume bars in Chart 3 show that upside volume hasn’t been keeping pace with the strong price action. That’s a logical chart spot for the QQQ to run into some profit-taking. Since it’s been leading the rest of the market higher, that also suggests profit-taking in the rest of the market. We have also pointed out that volume hasn’t kept pace with price gains over the last couple of weeks. That might also suggest that the stock rebound is due for a pullback of some sort. Initial chart support for the QQQ can be seen around the 164 level and its 50-day moving average (blue arrow).
Emerging Markets Are Also Struggling
The combination of a bouncing dollar and rising Treasury yields may be causing some profit-taking in emerging market stocks as well. The daily bars in the chart below shows the Emerging Markets iShares (EEM) dropping today. The EEM has also retraced more than two-thirds of its recent decline. Its 14-day RSI line (top of chart) is struggling to stay over the 50 line (red circle). The key support level to watch is its 50-day average (blue line). Any drop below that line would signal more profit-taking in store. Notice here also that upside volume during its recent rebound has been less than impressive.
Weekly Snapshot of Global Asset Prices
If you have any questions, please feel free to email me at email@example.com.
STA Investment Committee
Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)
Roth IRA Conversions – New Tax Smart Strategies for 2018
Written by: Scott Bishop
Most people know that we started 2018 with a brand-new tax law (the Tax Cuts and Jobs Act or “TCJA”). Some of the highlights of the TCJA can be found in this linked summary. In addition 2018 is also the 20th Anniversary of the Roth IRA!
In STA Wealth Management’s Retirement Survival Guide, I discuss Planning for Retirement the R.I.T.E. Way® (R.I.T.E. stands for “Retirement Income Taxed Efficiently”). The tax-free retirement Income available in retirement through Roth IRAs (and by using strategic Annual Roth Conversions) is discussed in the Guide and as part of our R.I.T.E. Plan. These strategies will be especially beneficial if we see future rises in our income tax rates (and we are currently at historically low tax rates). Thus, you should consider Roth IRAs as kind of “Tax Insurance” (by paying the “premium” of accelerating and paying taxes now on conversions). Click the link below to read the full article on Roth IRA Conversions.
Full Article Here
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