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U.S. ETFs: Quarterly Review

By Cumberland Advisors (David Kotok)ETFsJun 16, 2017 08:57AM ET
U.S. ETFs: Quarterly Review
By Cumberland Advisors (David Kotok)   |  Jun 16, 2017 08:57AM ET
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The Q2 stock market continued a concentration we saw in Q1. The stock components of the acronym known as FANG is the dominant reason for the strong market performance. FANG stands for Facebook (NASDAQ:FB), Apple (NASDAQ:AAPL), Netflix (NASDAQ:NFLX), Google (NASDAQ:GOOGL). Some add Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN); thus the acronym changes to FAANG or FAAMG. Bottom line: These very-large-cap tech-oriented stocks drove the averages like S&P or NASDAQ to new all-time highs in Q2 of 2017. In the ETF world, some exchange-traded funds held between 25% and 40% weight in those few stocks: examples are iShares US Technology (NYSE:IYW), PowerShares QQQ Trust Series 1 (NASDAQ:QQQ), First Trust Dow Jones Internet (NYSE:FDN), Technology Select Sector SPDR (NYSE:XLK), iShares North American Tech (NYSE:IGM), Fidelity MSCI Information Technology (NYSE:FTEC), Vanguard Information Technology (NYSE:VGT), and iShares Global Tech (NYSE:IXN). Note that QQQ and XLK are held in Cumberland portfolios. For reference, the sources for individual stock weight information are Bloomberg, The FORUM at ETF Research Center, and FactSet.

One school of thought among market observers is forecasting a market collapse led by these stocks. Their model is the tech stock bubble of 1999–2000. They point to many indicators including the ratio of stock market value to GDP. That ratio has reached about the same peak level as it did in the tech bubble.

The other school of thought sees a distinction between the tech bubble period and today. During the tech bubble, there were many companies without earnings. We used to call it the price/fantasy ratio. Collectively, companies without earnings added about $7 trillion in market value at the peak. True, companies with earnings were also excessively priced. Companies like Microsoft and Cisco traded in P/E ranges that were excessive.

This time around, the stock market’s new high is driven by companies with earnings, and the earnings are growing. At the same time, interest rates are very low, and the Fed has confirmed that it will stay on a gradual course for some period of time. So while we think the US stock market is not a cheap bargain, we do not see it as having entered the bubble mode we saw in 1999. It may get there, but it is not there yet. Recall that an equity risk premium (ERP) calculation requires two components: one is earnings yield; the other is an interest rate assumption. Actually we use several interest rate assumptions. So if rates are low and are likely to remain low, then earnings growth favors higher stock prices using the ERP concept. That is the state of the stock market investing world today.

Other detractors point to Washington chaos and the fading of prospects for the Trump policy agenda as a reason to sell stocks. We agree, but only in part. Were the economy stagnant or earnings not growing or monetary policy tight, we would certainly sell stocks. Troubles for Trump are not enough to exit the market. They do heighten concern. Buried in the news flow about special investigations is a movement to ease restrictions in the financial sector. That is why we have been overweight banks and continue in that mode. We think the bank stock recovery could be an extended bull market lasting the entire decade.

Speaking of the decade’s end, by 2021, it is possible we’ll see 3000 or higher on the S&P 500 Index. That outlook is based on continuing low inflation and slow, yet steady growth and relatively low interest rates. We think the short-term interest rate is 2% at the end of 2018 and that intermediate and long Treasury notes and bonds are a point or so higher. In such a long cycle, stocks can go higher and maybe much higher as long as earnings growth continues. We do not see any forces to derail them. As Q2 closes, we remain nearly fully invested. Of course that could change at any time and for many reasons, some of which can be event-driven.

by Cumberland Advisors

U.S. ETFs: Quarterly Review

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U.S. ETFs: Quarterly Review

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