A High Risk, High Reward Market Is Here

You can stop hunting for it. A period of higher risk and reward has arrived.

The global markets entered last week with a message: “Do we have your attention now?”  Whether it is rising rate and inflation pressure, corporate earnings concerns, the upcoming U.S. election, recognition of the massive buildup in corporate debt, or just bad memories of some past Octobers, what we have is the return of high market emotions.

So far, many investors have experienced a “Red October” after being comfortably in the black with S&P 500 Index funds, Nasdaq-infused portfolios and a general feeling that stock and bond prices were in no danger.  All the while, as I reported here recently, the bond market has been in a bear cycle for over 2 years, but no one seemed to notice until recently.  As is typical on Wall Street, now that a little shock and awe has occurred, everyone will notice it soon.

Here is something else to notice: even before last week’s mess, investment results for those with diversified portfolios was historically weak.  I say this because of the bottom-line results in the group of 100 ETFs I track.  These cover a wide swath of the global investment markets.  The events of last week only served to drive that point home further.

Through Friday, October 12, only 42 of those are up.  And only 24 of the 100 are up more than 2%.  Translation: 2018 has NOT been a terrific year for investment returns.  It has, however, been a year in which risks of losing large amounts of your hard-earned capital have skyrocketed.  That does not mean that we stop investing but it does mean that we adjust our approach to accommodate that higher risk.

The S&P 500 Index was the 15th best performer for 2018 through last Friday, with a total return of 4.76%.  But as I have noted ad nauseum this year, that index is fooling investors into thinking that investment conditions are just fine, when in fact risk has been rising all year.  The 2 charts below show the hard evidence:

Above, you see ETFs representing the S&P 500, the S&P 500, the S&P 500 and a couple of others.  That is not a misprint.  The first 3 are all ETFs that own the stocks in the S&P 500.  The one at the top is the “classic” S&P 500, the one that weights the stocks based on how large they are.  That’s the one that is misguiding investors and has been for years.  It makes them think that “the market” is doing really well, when in fact it is a slice of the market doing well.  At other times, other slices will do well and this one won’t.  But try telling that to the FOMO (Fear of Missing Out) crowd.

The second row is the same stocks, but not weighted by size.  They are weighted equally.  In other words, year-to-date, the average S&P 500 stock is up 0.87%.  And only briefly was the average stock up more than 4% at any point this year.

The third row is the S&P 500…minus technology stocks.  Positive for the year, but pedestrian gains they are.  The fourth row is an ETF that tracks the 80 highest-yielding S&P 500 component stocks.  It is now down for the year, and has not really been much above flat most of the year.  Bull market in 2018?  Not for yield investors.

Lastly, we find the ETF that tracks Social Media companies.  These were market leaders from the time this ETF was launched in late 2015 through the first quarter of this year, rising over 110% during that time.  But that group of recent market leaders has faltered badly since, and for 2018 it is off 10% (and not shown, it is down 22% from its high…its own private bear market, if you will).

This second chart shows the same 5 ETFs, but on the same graph, and only since the S&P 500 hit what was essentially its peak for the year, back on January 26.  History will either conclude that 2018 was the top of a long bull market, or a consolidation of those heady gains before yet another leg higher.  As an investor and strategist, my job is not to predict those things as much as it is to gauge what represents potential reward, and the associated risk of major loss that accompanies that potential reward.  This second chart shows a market that is at the very least getting “heavy.”  Because after all, the pundits can chatter, and the analysts can tout, but when it is all said and done, it is price that rules.

Still, you might think that all this talk of higher risk is just rubbish.  And in that case, click on a different article, and please avoid any references to market history involving the years 1973-1974, 1987, 2000-2002 or 2007-2009.  They won’t mean much to you.  For the rest of us, the fourth quarter might just be a time when those with a plan for multiple market environments separate themselves from those with no plan, but a lot of recent success.

For research and insight on these issues and more, click HERE.

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