Bullish commentators have been busy admonishing those who might be cautious. Their reasoning? Long-term investors should focus on the signs that point to stable economic growth in the U.S., a recovery in China as well as unwavering stimulus by the Federal Reserve. Besides, with Treasuries offering more risk than reward, where else are you going to realize a worthwhile return on your money?
However, a number of Fed policymakers recently expressed reservations about the amount and the duration of the central bank’s bond-buying program. In other words, current monetary policy that artificially depresses interest rates may not continue indefinitely. Moreover, the idea that economic growth in the U.S. will demonstrate ongoing signs of stability and/or improvement discounts the high probability of a sequestration drag; indeed, automatic spending cuts are likely to hamper job growth, curb consumer spending and crimp investor confidence.
Between the finger-pointing in Washington and the release of the Fed minutes, the S&P 500 logged one of its worst performances of the year (-1.25%). At least in the immediate term, bulls and bears both appear to be growing more anxious about ownership of riskier assets.
Was this session merely a one-day bout of profit-taking? Or did the move to the downside represent a tipping point for future sell-offs? I have listed 3 ETF indicators for evaluating the current investing environment.
1.Â ProShares UltraShort Euro (EUO). Eager risk-takers have been climbing aboard the “Europe Express,” determining that central bank assurances to do whatever it takes to save the euro signaled an end to Europe’s debt crisis. I’m not so sure. Greeks are currently marching against austerity as I type, Spain’s recession is deepening and Italy’s upcoming election could upset the proverbial apple cart.
Equally worthy of note, the Fed may or may not scale back on its bond buying. That might bolster the greenback. And Spain may find itself asking for a formal bailout, which would depress the euro.
As recently as the first day of February, the euro sat at 52-week highs and EUO rested at 52-week lows. Today, EUO is on the verge of rising above a near-term trendline. The further EUO climbs, one might expect riskier stock assets to fall.
2. iShares DJ Home Construction (ITB). I experienced a bit of criticism for suggesting that it is a bad idea to buy any fund when its price is 22% above a 200-day moving average. Well, ITB has lost about 7% in value, so it’s not quite as overbought as it was when I last discussed the matter.
More critically, U.S. homebuilder confidence fell in February, while actual housing starts dropped 8.5% in January. Equally disconcerting, the upcoming sequestration cuts may have an adverse effect on real estate, from Superstorm Sandy reconstruction endeavors to the processing of FHA-backed home loans.
Low mortgage rates and the real estate recovery story have fueled the stock market. If ITB continues to deteriorate below its 50-day trendline and struggle there, a corrective phase for stock assets could take up residence.
3. PowerShares S&P 500 Low Volatility (SPLV). Â One of the easiest mechanisms for tracking changes in relative strength is a price ratio. For example, when low volatility funds like SPLV are underperforming the S&P 500 market at large, the SPLV:SPY price ratio would decline. In 2012, market peaks occurred near April and early September… when the SPLV:SPY price ratio hit low points.
In contrast, when SPLV:SPY is rising, and when it climbs above key trendlines like the 50-day, risk aversion may be back in vogue. The higher this ratio climbs, the better non-cyclical sectors perform (e.g., staples, utilities, health care).