Best Of 2016: Buy ETFs Like SPY On The Sell-Off
Why this probably isn't the start of a bear market.
[Editor's Note: We are rerunning some of our best stories from 2016.]
The first few trading sessions of 2016 have been historical. Down as much as 8% in less than two weeks, it's been the worst start for the U.S. stock market in history. Is this simply a correction or something more ominous?
Sell-Off Like Deja Vu
In many ways, this latest stock market sell-off is like deja vu: Investors are heading for the exits due to concerns related to China and the implosion in oil prices.
If that sounds familiar, it's because the market sold off for those exact same reasons back in August 2015. That downturn was fast and furious, just like the current one, with investors bracing for the worst, despite relatively healthy economic data coming out of the U.S.
From a summer peak of around 2,135, the S&P 500 hit a low of 1,867 on Aug. 24―a 12.6% correction. The index consolidated above the lows for the next month before taking off like a rocket in October on the back of relatively strong earnings reports for the third quarter.
Ultimately, the S&P 500 was able to reach a high of 2,116 before it peaked again. Unable to make headway to new highs, the market became toppy and vulnerable to a new wave for selling, which began with a vengeance with the start of the New Year.
Potential Bottom
Today the S&P 500 reached as low as 1,879―just a hair above the lows from last year—before bouncing more than 1% to 1,915. Will the market ultimately bottom out here again, or plummet even lower?
1-Year Chart For S&P 500
It's anyone's guess as to where the market goes in the short term. However, with investor sentiment sour, and no signs that the weakness abroad will push the U.S. into a recession, it looks like this could be another buying opportunity.
To be sure, it's not all roses out there. The crash in raw materials prices poses challenges for certain segments of the economy, and China's slowdown hurts global growth. But neither factor is likely to meaningfully derail the U.S. economy or the U.S. earnings outlook, which is the lifeblood of the stock market.
Exports to China represent only 7% of total American exports, according to Wells Fargo. Likewise, energy companies only make up 6% of the S&P 500 in terms of market capitalization.
Energy Earnings Baked In
Moreover, the hit to aggregate earnings from the energy sector is largely baked into the market. According to FactSet, overall earnings for companies in the S&P 500 are expected to have declined by only 0.9% in 2015 (a number that could turn out to be positive if companies beat analyst estimates, as they typically do).
Excluding the nearly 60% decline in energy sector profits, S&P 500 earnings are actually forecast to have risen by 6% for the year.
In 2016, with less of a year-over-year drag from energy prices (and less of a drag from the soaring dollar, which hurts profits for multinationals), earnings may resume their climb to record highs, pushing the stock market up in turn.
Buying Opportunity In Broad Market ETFs
While the ingredients are certainly in place for a market rebound, there's no telling what the market is going to do in the near term. In any case, investors should be positioned to withstand continued volatility.
For investors who can handle the outsized moves, the broad-based U.S. stock market ETFs may be ripe to buy, with prices well off of their highs.
The SPDR S&P 500 ETF (SPY) looks attractive after the recent double-digit sell-off from the highs. The iShares Core S&P Mid-Cap ETF (IJH), down 18% from its highs, and the small-cap iShares Russell 2000 (IWM), down 22%, also look compelling.
Returns For SPY, IJH, IWM Since Summer 2015 Highs
The Bottom Line
With the U.S. economy humming along, it doesn't look like the inevitable bear market in stocks has arrived. Rather, the sharp drop in the market looks like another correction in the broader uptrend. A reacceleration in corporate earnings in 2016 may be the catalyst that sends prices back up later this year.
At the time of this writing, the author held no positions in the securities mentioned. Contact Sumit Roy at [email protected].
