Market Correction’s Meaning For ETFs

October has a notorious reputation among stock market watchers. It’s typically not a bad month—over the past 50 years, the S&P 500 has averaged a gain of 0.85% during the period—especially compared with September or February, which average a loss.

But October is a month that has featured some of the worst stock market declines in history. Eye-popping drops, like the 1987 “Black Monday” crash, as well as a large part of the 2008 financial crisis-driven meltdown, took place during October.

It’s no wonder then that investors got spooked when stocks began falling this October. The drip lower began slowly, initially regarded as an overdue pullback after the major indices notched record highs in September. But soon the sell-off accelerated and now has some investors running for the hills, panicked that this could be the start of something bigger.

2018 Gains Wiped Out

This month alone, the SPDR S&P 500 ETF Trust (SPY), the world’s largest exchange-traded fund, is down 8.7% after falling in 14 of the last 18 sessions through Oct. 24. For the year as a whole, the ETF is barely hanging onto a 0.7% gain.

Yearly Gains Wiped Out

This is the third correction of more than 8% for SPY this year. In February and March, the S&P 500 experienced similar, sharp declines on the back of nearly identical worries about rising interest rates and trade wars.

October’s stock market sell-off has hit shares of smaller companies even harder than their larger counterparts. The iShares Russell 2000 ETF (IWM) and the iShares Core S&P Mid-Cap ETF (IJH) slid 13.4% and 11.4%, respectively, putting both solidly in the red on a year-to-date basis.

Though they are less sensitive to trade jitters than large-caps, stocks of smaller companies have underperformed, as investors worry that higher interest rates will hurt them the most.

YTD Returns For SPY, IJH, IWM

Falling Back To Earth in October

Also underperforming? Former high flyers and economically sensitive sectors. The SPDR S&P Internet ETF (XWEB), once the top-performing nonleveraged ETF of the year, plunged 15.9% in October; the ROBO Global Robotics and Automation Index ETF (ROBO), another high flyer, lost 16.3%; and the ETFMG Alternative Harvest ETF (MJ), a popular marijuana fund, spiraled 21.5% lower.

Meanwhile, among Vanguard’s suite of 11 U.S. sector ETFs, energy and materials have been the worst hit, with consumer discretionary, industrials and technology close behind. ETFs tied to those sectors swooned 11-13% so far this month.

The only U.S. equity sectors to rise in October are two noncyclical, defensive groups: utilities, up 4.1%; and consumer staples up 1.1%.

The Vanguard Real Estate ETF (VNQ), mostly comprising real estate investment trusts, fared relatively well, with a modest 3.2% pullback this month, even as other real estate-related ETFs like the iShares U.S. Home Construction ETF (ITB) tumbled 16.1% in the same period.

October Sector Returns

Data measures total return for the month-to-date period through 10/24/18.
 

Overseas Troubles

Outside the U.S., performance has been just as shaky in October. The iShares MSCI Eurozone ETF (EZU) and the iShares MSCI Italy ETF (EWI) shed more than 11% apiece amid Italian budget concerns. Both ETFs are at 19-month lows as investors watch the Italian budget saga play out.

The European Union has ordered Italy to reduce its proposed budget deficit, something that populist government has refused to do. Amid the friction, rates on the country’s 10-year sovereign bond spiked to four-year highs this month.

Meanwhile, the economic situation is just as perilous in China, which saw its economy grow at the slowest rate since 2009 in the third quarter. The Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR), sagged 9.3%, and the iShares Core MSCI Emerging Markets ETF (IEMG) slipped 10.4% this month.

Emerging market stocks are now at levels last seen in early 2017, while you’d have to go back to early 2016 to see China stocks trading so low. Investors are nervous the trade war between the U.S. and China is starting to take a toll on both countries’ economies, but especially China’s.

U.S. tariffs on $200 billion worth of Chinese goods will increase from 10% to 25% at the start of next year, which could exacerbate the already-tense trade war.

Bottom Line

No doubt about it: Investors are spooked. They’ve bid up option premiums, sending the Cboe Volatility Index (VIX), the market’s “fear gauge,” to more than 25 for the first time since April, catapulting shares of the iPath S&P 500 VIX Short-Term Futures ETN (VXX) to a 46.2% monthly gain.

And it’s not just because of Halloween; there are plenty of legitimate reasons investors are worrying about the global economy.

That said, investors will now wait to see whether this latest correction turns out to be just like all the others in the nine-year bull market—a buying opportunity—or if it’s the start of a bigger downtrend in stocks.

For now, most analysts aren’t throwing in the towel on the bull. They see a market that is now trading at only 15 times next year’s earnings estimates, the lowest since 2016, as cheap. And even as trade and rate concerns linger, they see a U.S. economy that, according to the latest figures, is firing on all cylinders.

On the flip side, the bears see a too-aggressive Fed and continued escalation in the trade war as factors that will derail the economy and corporate profits. The synchronized global expansion of last year is slowly turning into a synchronized slowdown, and the U.S. will likely be the last economy to fall, they say.

Relax: Markets Move

Regardless of which camp proves right, long-term investors shouldn’t panic.

Large market drops are always hard to stomach, but shouldn’t alter your investment strategy.

Short, sharp market corrections are common. Bear markets are much rarer, and though they are inevitable, are extremely difficult to predict.

Email Sumit Roy at [email protected] or follow him on Twitter sumitroy2