ETF Investors: Expect More Volatility In October

By
A A A

ETFs across the board scored notable gains in the third quarter as stock markets defied the historical precedent for September being the worst month of the year. But if history holds true in October, investors best buckle their seatbelts.

"October has a frightful history of market crashes and only ranks midpack in post-election years," the Stock Trader's Almanac wrote in a client note Sept. 26. "Should a meaningful decline materialize in October it could prove to be an excellent buying opportunity."

October is historically the last month of the Dow and S&P 500's worst six months of the year and the last month of the Nasdaq's weakest four months, according to the almanac. The research firm sees the market getting stuck in a range because of the unpredictability of the Federal Reserve's next move, who will take over for Chairman Ben Bernanke and the outcome of the U.S. debt ceiling debate.

SPDR S&P 500 ( SPY ) rose almost 3% in September, pushing its Q3 gain to almost 5%.

Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch, supports the "buy the dip" strategy, based on evidence of strong economic growth underway. His year-end target for the S&P 500 is 1750, up about 4% from its September close, and which translates to $175 a share for SPY.

"Real estate prices (up across the world bar Europe), purchase mortgage applications (at an eight-week high) and credit availability (lending to small business is up for the first time since 2008) all argue that gross domestic product estimates are more likely to rise than fall, in our view," Hartnett and his colleagues wrote in a report Sept. 26.

Rising U.S. home prices lift consumer confidence and dissipate the threat of recession, they reason.

But Mark Arbeter, S&P Capital IQ's chief technical strategist, is "raising the yellow flag," based on technical analysis and momentum indicators. "We also now see the potential for a bearish head-and-shoulders pattern with the left shoulder and the head already formed," he wrote in his weekly technical report issued Sept. 27. His downside target for this formation would be a 12% correction from the S&P 500's new high near 1730.

Falling stock prices are seen benefiting gold and Treasuries.SPDR Gold Trust ( GLD ), the largest ETF tracking the yellow metal, fell about 4% in September, trimming its Q3 gain to about 8%. Gold has formed a bullish inverted head-and-shoulders pattern, while market sentiment remains bearish. A break above $1,434 an ounce in spot gold or 143.40 in GLD would confirm this outlook.

IShares Barclays 20+ Year Treasury Bond ( TLT ), tracking long-term bonds, edged up 0.4% in September, cutting its Q3 loss to about 4%. The yield on 10-year notes soared from 1.66% on May 2 to 2.98% on Sept. 9 on expectations the Fed will scale back its economic stimulus. The yield eased to 2.64 by Sept. 27.

Arbeter notes that Commitments of Traders reports appear bullish for bonds. Commercial traders and large speculators -- the so-called smart money -- are heavily bullish on bonds, while small speculators -- the so-called dumb money who are usually wrong -- are very bearish.

Foreign ETFs

IShares MSCI EAFE Index ( EFA ), tracking developed foreign markets, outpaced both the U.S. and emerging markets, returning about 11% in Q4 after climbing about 8%.IShares MSCI Emerging Markets Index ( EEM ) returned about 6% in Q3 after rallying 7% in September.

Market Vectors Indonesia Index ETF (IDX) soared nearly 9% the day the Federal Reserve shocked the market by standing pat on its stimulus program. But it has since given back all of its gains plus some.

Indonesia -- which plunged about 21% in Q3 -- suffers from a flurry of what Credit Suisse analysts call "negative synergies" that make it especially vulnerable to eventual tapering. It has the largest trade deficit among emerging markets and heavy foreign ownership of its bonds, leaving it vulnerable to a sharp sell-off.

Soaring inflation coupled with a rapidly depreciating currency erodes real earnings growth and threatens consumer spending. Rising oil prices increase government spending on subsidies, while falling commodity prices, especially coal, dampen export income.

"The economy outpaced its sustainable growth rate for three to four years on the back of the post-global-financial-crisis commodity boom and easy monetary conditions, and is now destined for two to three years of subtrend growth," Credit Suisse analysts wrote in a report released Sept. 25. "A period of weaker activity will help correct the imbalances, including the current account deficit that built up during the earlier period of excess."

Value Trap?

EEM's holdings trade at an attractive valuation of 10 times forward earnings vs. 13.5 for EFA and 15 for SPY, which may entice value investors. But it may be a value trap in light of slowing economic growth and rising inflation.

The purchasing managers index for emerging markets is at an 11-year low and below those of developed countries, Credit Suisse reported Sept. 27. Its strategists believe emerging market currencies could weaken further because of high debt levels and shrinking trade surpluses. Companies are returning production to their home countries because of rapid wage growth in developing countries. Inflation, which Credit Suisse sees rising to 5% next year, lowers real incomes and earnings growth.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs

Referenced Stocks: EEM , EFA , GLD , SPY , TLT

Investor's Business Daily

Investor's Business Daily

More from Investor's Business Daily:

Related Videos

Stocks

Referenced

Most Active by Volume

55,414,702
  • $15.38 ▼ 0.39%
38,503,210
  • $66.34 ▲ 2.26%
36,466,704
  • $8.36 ▼ 9.52%
35,253,294
  • $26.55 ▲ 1.34%
32,752,347
  • $6.55 ▲ 1.87%
31,778,001
  • $95.22 ▲ 0.19%
28,396,556
  • $51.49 ▼ 0.62%
23,800,987
  • $42.09 ▲ 0.97%
As of 7/11/2014, 04:03 PM