Key ETF Signals To Buy The Correction
It's typically a good idea to buy stocks amid September weakness.
The stock market remains in a funk. Nearly one month after the stunning decline of Aug. 24, risk asset prices still haven't regained their composure. Persistent worries about emerging markets (particularly China), tumbling commodity prices and uncertainty about Fed interest-rate hikes have plagued asset prices.
Compounding the market's troubles is the calendar. September is well-known as the worst month for stock market returns. In fact, it's the only month in which the S&P 500 has fallen more times than it has risen, according to S&P Capital IQ.
Fortunately, September is quickly fading into the rearview mirror, and the calendar will soon flip to October. That month is the second-worst-performing month of the year historically, but at least the average return is positive.
Looking even further ahead, November through January is typically the best three-month period of the year, and often sees what is called the "Santa Claus rally" in stock markets.
Plenty Of Time To Buy
In many ways, it's a good thing that stock markets have struggled during the past month. The back-and-forth price action above the Aug. 24 lows has given investors plenty of time to buy at attractive prices. It's also put the market on firmer footing from a technical perspective by washing out some of the excessive risk takers and complacency in the market.
This is in contrast to the last notable sell-off in markets almost a year ago. Back then, the market essentially saw a V-shaped recovery off of Oct. 2014's Ebola-related swoon.
Recession Unlikely
As difficult as it may be, it's usually a good idea to buy when stocks are down and fear levels are elevated. That's particularly the case when the fundamentals remain sound.
While China's troubles are certainly something to keep an eye on, they're unlikely to push the U.S. into a recession. They're also unlikely to take a big bite out of corporate earnings, which are forecast to grow by 4.4 percent this year despite the huge 38 percent decrease in energy sector profits.
No Sure Thing
Despite all signs suggesting that this latest pullback in markets is merely a correction in the bull market, nothing is guaranteed. Assets like stocks have historically delivered much higher return than safe assets like Treasurys because they're volatile and risky.
Ultimately, the only way to confirm whether the August-September decline was a correction or the start of something worse is in hindsight. Here are the key ETFs and indicators to keep an eye on as this potential bottoming process plays out.
S&P 500
The 12.6 percent correction in the S&P 500 refreshed the six-year-old stock bull market by removing some of the froth in the market. Now the index may be in the process of forming a strong base to rally from.
The S&P 500 bottomed out at 1,867 on Aug. 24 before reflexively rebounding to around 2,000 in the days after. Since then, it's bounced up and down in a range between about 1,900 and 2,000.
Meanwhile, the SPDR S&P 500 (SPY | A-99) ETF has closely tracked the underlying S&P 500, except on Aug. 24, when it briefly disconnected amid the mini "flash crash" on that day. That's why the peak-to-trough decline for the ETF is 14.7 percent, somewhat larger than the index.
Shanghai Composite Index
The bursting of China's stock market bubble was the initial catalyst that sent U.S. markets reeling. Some analysts feared that the deep, sudden plunge in Chinese shares was a reflection of troubles brewing within China's economy.
Interestingly, despite all the talk about the bloodbath in China's stock market, the Shanghai Composite Index is actually only modestly lower on the year (down 3.6 percent). That's because the recent sell-off has merely erased the enormous gains from earlier this year.
If China's stock market can stabilize here around the 3,000 level, that would remove some of the jitters associated with the world's second-largest economy.
On the ETF front, the Deutsche X-trackers Harvest CSI 300 China A-Shares ETF (ASHR | D-53) has lost 12.4 percent year-to-date, underperforming the Shanghai Composite Index. However, directionally, the ETF has largely tracked the Shanghai Composite Index.
Vanguard FTSE Emerging Markets ETF
Of course, China is not the only emerging market of concern. The whole developing world has faced troubles, as clearly illustrated by the performance of the Vanguard FTSE Emerging Markets ETF (VWO | C-89). The ETF has dropped 15.6 percent year-to-date, though it's up nearly 10 percent from its worst levels on Aug. 24.
VWO is a good proxy for emerging markets, and another indicator to keep an eye on.
iShares iBoxx $ High Yield Corporate Bond ETF
High-yield bond prices touched their lowest point in three years last month. In turn, ETFs like the iShares iBoxx $ High Yield Corporate Bond ETF (HYG | B-64) were yielding more than 7 percent, significantly above the equivalent Treasury yields.
Fears about bond defaults in the energy sector rate hikes, and general economic uncertainty, have taken their toll on HYG and similar ETFs.
A rise in credit spreads is never a good thing for economic growth and stocks; thus, this ETF is worth closely monitoring. The low for HYG, unsurprisingly put in on Aug. 24, was $83.43/share, while current prices are around $85.
CBOE Volatility Index
One of the main market fear gauges, the CBOE Volatility Index (VIX), spiked dramatically when the market tumbled to its lows on Aug. 24. From a high of more than 53, the VIX has since fallen by more than half, to around 22.
That signals that investors aren't nearly as concerned about a market drop as they were a month ago. In fact, the VIX is now only slightly above its long-term average of 19.84.
Crude Oil
Many investors have expressed concerns about the rapid and relentless plunge in commodities. There's no better illustration of this than crude oil, which dipped as low as $37.75 in August for the first time since the financial crisis.
The plunge in crude has had a direct impact on corporate earnings by slashing the profits at U.S. energy companies. It will certainly be a positive for market sentiment if crude stops falling. Currently about $46/barrel, benchmark WTI crude oil futures are solidly above recent lows.
Contact Sumit Roy [email protected].
