When Market Highs Are About Perception

September 21, 2017

This article is part of a regular series on thought leadership from some of the more influential ETF strategists in the money management industry. Today's article is by Robert Michaud, chief investment officer of Boston-based New Frontier Advisors.

Investors often raise concerns when the stock market is near an all-time high. The question often is, will it go even higher or will it begin to fall?

We can't know, but as a general rule, it’s not a good idea to sell simply because the market reaches a new high. If anything, historic evidence suggests returns going forward from a market high are typically superior to average market returns.

But the rising 2017 U.S. stock market is a little different from many in the past. While the market has risen year-to-date, the dollar has fallen relative to other currencies.

Note that international investors may not perceive the U.S. to be at a market high. To illustrate this, I adjusted the S&P 500 by the dollar index on a daily basis and compared that to the level of the unadjusted S&P 500. The dollar index measures the value of the dollar relative to a basket of international currencies.

Resulting Peaks

There are two ETFs—the PowerShares DB US Dollar Index Bullish Fund (UUP) and the WisdomTree Bloomberg US Dollar Bullish Fund (USDU)—as well broad indices based on global currencies that they all tell the same story: Adjusting by UUP, USDU or the “broad index” results in peaks for the U.S. market within one day of each other.

The two return series generally coincide until the market high of March 1, but after that, they sharply diverge. Since March 1, U.S. markets have risen to new highs, but when adjusted for the falling dollar, the market remains significantly below the March 1 high (-6.2% as of Sept. 11, 2017).

Perhaps more strikingly, international investors could have perceived a small overall decline in the U.S. market this year. These results paint a very different perception of international market sentiment in U.S. capital markets.



But these results are also important for U.S. investors. From a purchasing-power perspective, the U.S. market peaked at the beginning of March.

Clearly, some of the gains in the U.S. stock market must be attributed to increased competitiveness of exports and the appreciation of foreign assets for multinational companies. Domestic political uncertainty may also be an important factor.

Growth Expectations?

This calls into question how much of the recent rise of the stock market is associated with expectations of future growth and the health of the economy. The global economy is not valuing the U.S. market as much as the market high would suggest.

Investors in ETFs with exposure to the dollar such as the SPDR S&P 500 ETF Trust (SPY) may want to consider broader international diversification, either through an optimized portfolio balancing the risks of many domestic and international ETFs, or broad global exposure through ETFs such as the Vanguard Total World Stock ETF (VT) or the iShares MSCI ACWI ETF (ACWI).

At the time of writing, the author held no positions in the securities mentioned. New Frontier Advisors is a research and investment advisory firm. We do not subscribe to any one method of investing; rather, we focus on defining strategies that reduce risk and deliver solid returns across uncertain future market conditions. For a list of full disclosures, please click here.


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