Yellow lights may not signal that a driver should slam on the brakes. On the other hand, anyone who has ever pushed the pedal to the floor to make it through an intersection has been burned by a speeding ticket or three in his/her lifetime.
Similarly, when warning signs appear, investors should not abandon every exchange-traded asset in their vehicle. Yet ignoring significant impediments to sustainable price appreciation is likely to cause emotional stress at best and undesirable financial hardship at worst.
One week ago, I gave readers and listeners 3 ETFs for tracking the probability of a market correction. And while these indicators are by no means intended to predict the future, they are intended to provide insight for evaluating risks relative to rewards.
For those who may not wish to review my commentary in its entirety, the ETFs included Proshares Ultra Short Euro (EUO), PowerShares S&P 500 Low Volatility (SPLV) and iShares DJ Home Construction (ITB). With respect to EUO over the last week, it climbed significantly above its 50-day moving average, clearly indicating that the euro-zone, its currency and its ongoing debt crisis may thwart stock advances. Similarly, the SPLV:SPY price ratio continues to rise further above a 50-day trendline, demonstrating greater relative strength for defensive stocks like staples, health care and utilities. Even ITB is struggling to stay atop its 50-day.
In spite of these 3 indicators hinting that a more substantive pullback may grip equities, the S&P 500 still sits near 1510 at the mid-point of the trading day (2/27). That’s roughly a single percentage point below 2013 highs. In my estimation, however, it will be very difficult for U.S. stocks to scale the increasing number of worries on the wall without first experiencing an anxiety-riddled sell-off.
Here, then, are 2 more ETF indicators that you may wish to follow.
1. iShares Barclays 20+ Year Treasury (TLT). At the end of January, nearly every financial web site and nearly every important financial news source discussed the “Great Rotation.” In brief, investors were leaving bond funds for the sunnier shores of stock funds. What’s more, one would now have to contend with bond price depreciation if they made the mistake of sticking around. After all, the 30-year bond bull was officially over.
On the one hand, I have not been interested in owning long-dated treasuries because the yield barely compensates one for the risk of participation. Moreover, the idea of seeking price gains in treasuries tends to fly in the face of why one owns an income investment. On the flip side, the “Great Rotation” may not only be vastly overstated, it may be exceptionally misleading. Not only is the Fed actively engaged in purchasing U.S. debt to depress interest rates, but euro-zone woes as well as the U.S. sequester are likely to bolster demand.
It follows that iShares Barclays 20+ Year Treasury (TLT) still has the “mojo” to tell us when riskier assets might wane. For example, if TLT climbs above and holds above a 50-day trendline, near-term risk of stock market participation may be elevated.
2. PowerShares DB Italian Treasury Bond ETN (ITLY). This morning, I read a tweet that admonished those who were making a mountain of Italy’s molehill. From the perspective of the angry tweeter, Italian bond yields are no higher than they were a few months ago… so why all the hoopla?
What the author fails to realize, however, is that trends are what make or break bull markets. For example, if China’s economic growth is trending from 10% to 9% to 7.5%, its stock market fears the direction of the trend more than it is capable of embracing an absolute GDP number. Similarly, if the U.S. experiences genuine improvement in the jobs picture in 2013, the U.S. stock market may struggle with the possibility of a trend shift from loose monetary policy to tighter monetary policy.
In essence, then, we are more interested in rising Italian bond yields (falling government bond prices) than the absolute price/yield. If PowerShares DB Italian Treasury Bond ETN (ITLY) continues to deteriorate further and further below key moving averages, you are likely to see volatile price swings in stocks — both domestic and abroad.