Few would mistake the currentmarket action with what we saw
back in 2000, but it's increasingly clear that investors have
become conditioned to ever-risingstock prices.
The S&P 500 has posted a very impressive rebound over the
past 17quarters . In fact, over the past 20 months, the S&P
500 has risen 46%, which is what investors should reasonably
expect from the market over six or seven years.
There's no shame in staying involved in abull market , as long
as you show a great deal of discipline. An ever-rising market
requires you to start trimming the more aggressive and risky
portfolio holdings, maintaining a focus onstocks andfunds more
likely to hold their own when the inevitablemarket correction
"The line separatinginvestment andspeculation , which is
never bright and clear, becomes blurred still further when most
market participants have recently enjoyed triumphs. Nothing
sedates rationality like large doses of effortlessmoney ."
Buffett made those comments back in 2000. Since then, he has
repeated a simple notion: If you want to score solidgains , avoid
the crowd when it comes to the most popular investment trends of
the moment -- focus instead on unloved stocks and sectors.
Few investors are heeding Buffett's words. A review of thisyear
's most popular exchange-traded funds (
) shows that investors are pouring their money into what has
already been working in recent years and pulling money out of
For example, as the market has risen, volatility has virtually
disappeared. TheVIX , a key measure of expected market
choppiness, has fallen from above 80 in late 2008 to above 45 in
the summer of 2011 to a recent 13.
ETFs thatprofit from low volatility have attracted more than $5
billion this year in new inflows, with one-third of that coming
in April, according to BlackRock. In effect, investors are now
betting on volatility to fall further, even as this investment
angle appears to have largely played out.
Can volatility go lower? Not very much. In 2007, theVIX 's
20-year low was registered at 10.5. The potential rebound for the
VIX, on the other hand, is open-ended.
Or take the suddenly popular Japanese market as an example. My
colleague Jim Woods pointed out the appeal of the
WisdomTree Japan HedgedEquity ETF (
at the end of 2012.
Thefund has since risen a stunning 65%.
Trouble is, investors are still pouring money into this ETF.
According to S&PCapital IQ , this fund has been the topasset
gatherer this year with $5.3 billion in inflows. The
iShares MSCI Japan (
is close behind with $4.2 billion. Investors are chasing success,
which is precisely what they did in U.S. markets in late 1999 and
Of course, many other foreign markets aren't faring nearly as
well. The United States, Europe and Japan have delivered great
returns this year, but manyemerging markets have risen only
modestly. For instance, the
iShares MSCI Emerging MarketsIndex (
has fallen 2% this year.
How have investors responded to that underperformance?
They've pulled $5.4 billion out of that fund in 2013, according
to BlackRock. Yet the relative underperformance of emerging
market stocks and funds has led to a clear valuation gap. The
trailing 12-month price-to-earnings (P/E ) ratio on all of the
emerging markets held in the iShares ETF now stands at just 11,
well below the P/E of 15 for the S&P 500.
My point: If investors arebullish on the globaleconomy , they
should be buying the currently unpopular emerging-market funds.
In a similar vein, investors have been beating a hasty retreat
from commodities-focused ETFs: In April, more than $8 billion was
pulled from these funds, according to S&P Capital IQ.
Roughly a month ago, I took
of the sharp sell-off in commodities and at the time, noted that
"lower prices counterintuitively set the stage for the next bull
market in commodities," as supply is reduced and pricing starts
to strengthen anew. It's a bit premature tospot acommodity rally
just yet, butcontrarian investors would do well to start
sharpening their pencils in this investment niche.
The Fixed-Income Conundrum
Investors' need for income-producing stocks and funds is
understandable. Withbond yields from blue-chip issuers such as
offering yields below 3%, investors have instead been focusing
squarely on thedebt issued by less creditworthy corporations.
These kinds ofbonds are called "junk" for a reason. They carry a
higher risk ofdefault , though we've seen few majorbankruptcies
recently. Still, the ardor for these higher-yielding riskier
bonds has led to a furious rally, pushing the historical yields
from the 6% to 8% range to below 5%.
That's the result of billions pouring into high-yielding bond
funds such as the
PIMCO 0-5 High YieldCorporate Bond Index ETF
iShares iBoxx $ High Yield Corporate Bond ETF
. At some point in this economic cycle, thesehigh-yield bonds
will experience risingdefaults , which could well lead to a
furious exit from this riskier corner of thefixed-income market.
Risks to Consider:
Some of these ETF niches are in a mania phase, which can last
for an extended period, so it's unwise to short them until clear
signs of a market shift have emerged.
Action to Take -->
The main lesson isn't that you should avoid this market. Instead,
you should avoid its most popular niches and redirect assets into
unloved niches, such as emerging markets and commodities. I
remain a big fan of automakers and their suppliers, along with
insurers, as they represent deep value in this rising market.
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