This past week, I read an article about UBS’ take on where the market is heading over the next 12 months or so. UBS is forecasting another 9% gain for the S&P 500 in 2018, which would mark the 10th straight year of positive returns if true. Also discussed were two of the biggest fears gripping Wall Street right now, which I wanted to address individually.
“Stocks are overvalued, and global equities are in a bubble”
The market is expensive compared to long-term historical averages, but just how expensive? Thanks to several strong quarters of earnings and revenue growth, the forward P/E on the S&P 500 now has come down to around 19. Given reasonably strong GDP growth, solid earnings and low inflation, this number isn’t that unreasonable. The Shiller P/E, which looks at inflation-adjusted earnings over the past 10 year, suggests the market has only been this expensive at one other point in history - the dot-com bubble.
At this point, I think the forward P/E gives a better indication of where the economy and the markets are at. But it’s difficult to find a short-term catalyst that could move the markets significantly lower. Keep an eye on interest rates though. High valuations can be supported as long as rates remain low. If rates start shooting higher, a correction could be in the offing.
“Central-bank tightening will suck the life out of stocks”
This is what I’ve said is the most likely cause for a short-term pullback. It really depends on how fast the Fed decides to lift rates. It seems very likely we’ll see a rate hike in December, while the Fed Dot Plot suggests three more moves higher in 2018. Janet Yellen has suggested several times that the Fed will lift rates gently and will only gradually start drawing down the balance sheet. If that holds true, there’s no reason to think that interest rates could normalize while the bull market continues. A Fed that moves too quickly could end up stifling economic growth, but it seems pretty determined to not let that happen.
It’s smart to keep a cautious tone when looking forward, but it doesn’t feel like there’s an imminent market pullback at this point. An underrated factor in continuing the stock market rally could be ETF flows. ETFs have taken in more than $300 billion in 2017, and that number is expected to rise to over $400 billion in 2018. Steady buying demand could help keep a floor under stocks for much of the next 12 months. Regardless, it doesn’t look like panic is warranted at this point.
Here are your four ETFs to watch in the coming week.
PowerShares Dynamic Retail ETF (PMR)
It’s going to be a heavy earnings-driven week for the retail sector and for the Dynamic Retail ETF in particular. Top 10 holdings Walmart (WMT), Home Depot (HD), Best Buy (BBY), Ross Stores (ROST) and Children’s Place (PLCE) all report their quarterly results. Also coming this week are results from The Gap (GPS), The Buckle (BKE), Target (TGT), Abercrombie & Fitch (ANF), Foot Locker (FL) and Dick’s Sporting Goods (DKS).
In something of a surprise, there’s actually some optimism coming out of the retail space. Kohl’s (KSS) delivered disappointing results this past week, but Baird upgraded the stock to “outperform” arguing that the retailer is well-positioned for the holiday season. Macy’s (M) shot ahead 11% on Thursday on better than expected results.
Others: SPDR S&P Retail ETF (XRT), VanEck Vectors Retail ETF (RTH), Amplify Online Retail ETF (IBUY)
iShares iBoxx $ High Yield Corporate Bond ETF (HYG)
Junk bonds took an unexpected beating this past week prompting some traders to wonder if this is much ado about nothing or a sign of things to come. Without a clear catalyst in sight, the sell-off in junk bonds has some worried that this could be a precursor to a drop in equities. Junk bonds tend to behave more like stocks than bonds, so any signal that investors are taking risk off the table could be taken as an indicator that equities may be the next asset class to go. Equities have remained steadfast thus far, but watch to see if the two groups start to move in tandem again.
Others: SPDR Barclays High Yield Bond ETF (JNK), SPDR Barclays Capital Short Term High Yield Bond ETF (SJNK), iShares 0-5 Year High Yield Corporate Bond ETF (SHYG), PIMCO 0-5 Year High Yield Corporate Bond Index ETF (HYS)
Tierra XP Latin America Real Estate ETF (LARE)
ETF issuers who bring funds to market are under no obligation to keep the fund’s index, its managers, objective or really anything else. PureFunds found that out the hard way when it was unceremoniously dumped by ETFMG from nearly a half dozen funds, including the popular Cybersecurity ETF (HACK). It’s about to happen again.
The Latin America Real Estate ETF hasn’t had a problem with performance. Since its inception at the end of 2015, the fund is up a total of 36%. But it has failed to gain traction. It still has only $6 million in assets, so ETFMG decided to make a change. Later this year, the Latin America Real Estate ETF will become the Alternative Agroscience ETF, specializing in legal marijuana companies. It’s a notable change because the new fund will be the first marijuana ETF traded in the U.S. (the Horizons Marijuana Life Sciences Index ETF (HMMJ) trades on the Toronto Stock Exchange), but it’s an unfortunate end for an ETF that actually did pretty well.
Vanguard Total Corporate Bond ETF (VTC)
Vanguard launches its first new ETF since the debut of the Vanguard International Dividend Appreciation ETF (VIGI) and the Vanguard International High Dividend Yield ETF (VYMI) back in February 2016. The Total Corporate Bond ETF is a fund-of-funds that uses the Vanguard Short-Term Corporate Bond ETF (VCSH), the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) and the Vanguard Long-Term Corporate Bond ETF (VCLT). Currently, the allocations are 38% to VCSH, 31% to VCIT and 31% to VCLT.
The most interesting thing about the fund is that it’s “free”. By that, I mean that Vanguard is not charging a layer of expenses on top of those of the underlying Vanguard ETFs. VTC has an expense ratio of 0.07%, the same as each of the three underlying bond ETFs.
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