- Just as indexers have driven SPY and QQQ up to overvalued levels, if they panic sell, they will drive those indexes to undervalued levels.
- China has driven Chinese stocks down to about “fair value.” The question now is, will they get outright cheap?
- For core large cap asset allocation, QQQ crushes SPY, but it might not be that way forever.
- Efficient markets work well with indexes, small caps you should patiently pick out a basket of 12-20 stocks with asymmetric upside to add to your ETF asset allocation.
The Global Trends ETF Report is a weekly update of broad market risks and trends, as well as, Plug & Play ETFs to focus on now.
Today we will summarize some very big themes for the core of our portfolio the next 5-10 years. Grab something to drink.
The S&P 500 is down about 3% the past two weeks. Nothing abnormal, it just seems that way given the recent past. Given…
- historically high valuations
- hundreds of stocks barely coming off of overbought signals
- Fed tapering approaching the front windshield
- slowing economic growth after the rebound pop
- potential recession in China amid Xi crackdown on stuff he doesn’t like
- inflation this and inflation that
- the debt ceiling threatening U.S. debt default in Q4
- potential for a less than hoped for fiscal package out of Congress
- McConnell & McCarthy being McConnell & McCarthy
- climate change
- evidence that aliens probably are real
- several of my succulents tilting oddly to the left
…the question is: what the heck actually matters?
My short-term short answer: The Fed. The correlation is pretty clear between Fed activity and the stock market since the forever. It became more pronounced under Fed Chairman Alan Greenspan, more prounounced after the Great Recession and comically linked since the Coronavirus Crash:
My intermediate term short answer: Politics because they set the rules, regulations and taxes for a few years at a time. There is no doubt that the government picks winners, which implies they pick losers too.
My long-term short answer: either climate change or aliens and the Fed.
Right now, the historical overvaluations on the large caps driven by retail investors, primarily indexing via ETFs, and traders bidding things up with leverage and call options, are creating an S&P 500 that should it full revert to mean, could fall 70%. Several analysts of stature are saying that is the Armageddon scenario that could play out.
In my opinion, the odds of such a large correction are minute for a few reasons.
First, there’s a lot of money in the markets globally that can reposition, meaning, that at certain prices, many assets have a bidder.
Take Microsoft (MSFT), Alphabet (GOOG), Apple (AAPL), Amazon (AMZN) and Facebook (FB) for example. These 5 stocks represent about 22% of the value of the entire S&P 500 index. Short of an Armageddon situation, each of those would probably find large bids 15-30% below current levels even in a recession. So, the idea that a 70% decline in the broad S&P 500 when those 5 stocks have almost no possibility of falling that far, means a 70% drop in the S&P 500 is almost impossible.
Second, about a couple years after I said so on MarketWatch, Jeremy Grantham of GMO opined that maybe valuations are permanently higher than in the past. I don’t know about permanent, but quite possibly for a long time until interest rates normalize.
When might interest normalize to the historical 4-6% 10-year U.S. Treasury (currently about 1.25%)? Probably not until about half or more of the Baby Boomers have passed to that big market in the sky. Remember the entire “slow growth forever” theme: demographics drive economics. So, I don’t see the big “global reset” for a very long time.
Soon enough though, interest rates and the dollar will rise a little. It will happen because of inflation, or aliens, or more probably Fed tapering. When the Fed is removed (The Fed), or reduced, from the Treasury market, then the dollar will rise and we would likely see a correlated stock market correction.
How far that correction goes depends on when the money stops running out and idle money finds its way in.
I have said 20-30% is possible, but, a correction in the teens is the most likely, owing to demand for the five stocks I mentioned above which represent more than a fifth of the S&P 500 (SPY) and two-fifth of the Nasdaq 100 (QQQ).
As I mentioned several times the past couple years and in my last webinar, the Millennials, found on Reddit, social media and elsewhere, as well as, “kids” I talk to, are largely taking a “Will Rogers” approach to investing:
Don’t gamble! Take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.
Now, I think a lot of them skip the first sentence, but who cares. They are the marginal money in the markets now. The direction they run matters. A lot.
I have read and heard from a lot of Millennials that they plan to sell as soon as the upward momentum is over. I think they are trickling out now. If that becomes a stampede, a lot of stocks, especially the momo stocks, and the zombies, are going to get crushed. That’ll leave a mark on the indexes, but provide a pretty large opportunity.
Buy QQQ On A Correction
I began talking about a 100 zombies on the S&P 500 in late 2019 and brought it up again in my 2021 forecast:
I think there’s at least 150 zombies now which I define as companies with higher debt than their growth and profit prospects can pay.
Because the Fed helped virtually every company extend their debt by 5 or more years, the zombies will die slowly until they get wiped out by the bond vigilantes someday or they merge to hide their shrinkage.
Because of all the zombies in the S&P 500, I don’t want any piece of the SPDR S&P 500 (SPY) or Vanguard 500 (VOO). I’ll cherry pick the companies or sectors within the S&P 500 that I want exposure too.
For a broad index however, it is hard to beat the Invesco QQQ (QQQ) which is representative of the Nasdaq 100 and includes the five horses listed above. Look at QQQ vs SPY returns over a few time frames.
Entire run of QQQ since 1999 right before it crashed:
Notice QQQ still beats SPY.
From the Great Recession bottom:
The past 5 years:
Take away the S&P 500 comparison and you can see about where I see the buying range on QQQ supposing we get a correction:
In a minor correction, which is entirely possible, starting to scale into QQQ in the $330s is a fine strategy if there isn’t big downward momentum at that time. Again, I do think a price closer to $280s could happen. We’ll have to watch and act in real time.
Our Elliott Wave and Harmonics technical analyst, Scott “Shooter” Henderson, sees things similarly.
Presuming a “small correction” QQQ can be bought in the $340s.
Keep in mind, he’s a shorter term trader and would expect to swing trade (measured in months and weeks) it again soon after. I am looking for longer position trades (measured in quarters and years) so want to look for lower entries when I buy anything – especially a large cap index.
What could trigger those lower prices is fairly simple.
If that wall of worry up there causes losses and retail investors hit their pain point, they could exasperate the selling and push prices lower from a small correction to something worse. I noted above that Millennials seem poised to do such a flip flop. And, of course, Baby Boomers have always been emotional market participants, so they might “sell to save it” too.
The herd changing from FOMO buyers to panic sellers would cause a powerful downtrend.
It is certainly not impossible to think that QQQ reaching the $280s or even $240s, near peak 2020 prices, could be reached – this is a target area for some of the top technical traders I follow. What they and I don’t see are new lows.
There are mountains of smart money out there that can be shifted into buying stocks. That’s pretty smart money though, they won’t be “buying the dip” on a 5% or 10% correction. Think deep value and predatory investors with savvy. They’ll wait for at least some blood in the streets whenever the next “big one” comes.
The broad market getting dragged down will pull a lot of things down in the S&P 500 and even broader Russell 2000 (IWM). But, as I’ve discussed quite a bit the past couple months, there are plenty of small cap stocks that are already bargains due to the churning in the Russell 2000 since February:
That doesn’t mean I’d buy the Russell 2000 here though. It means, as I’ve detailed in our Plug & Play Stocks and Stocks Of The Week pieces is that there are a couple dozen small and midcap companies I like on top of the dozens I’ve probably not found yet.
Something to keep in mind. In less efficient markets, that is, with wider variance, such as small and midcaps, it pays to be a stock picker versus an indexer. This is where great money managers earn their pay.
Emerging markets are theoretically where a lot of money is going to be made in the next decade or two as more people move into the global middle class. I agree with that premise, but I also think that’s an enormous and inefficient space. So indexing doesn’t make a lot of sense in my mind. I want some semblance of stock picking.
When most analysts and investors talk about emerging markets they discuss the iShares Emerging Markets ETF (EEM). I hate that index. Here’s why:
Talk about a picture telling a million words. Where has that index made anyone other than bored every few years traders any money in 15 years? It’s just not a core holding. Will Rogers wouldn’t touch it with someone else’s lasso.
There are great emerging markets investments out there. And, if we had time to pick 20-30 more stocks from around the world, we could pick out those companies. But, time is fleeting. So we are tasked with finding a theme or two for investing and some themes are worth investing in.
The theme in emerging markets I have gravitated to is the asset light internet, ecommerce and cloud space. This group has shown outperformance and has given me access to China which I don’t want to buy individual stocks in due to the commie factor.
Here’s the Emerging Markets Internet & Ecommerce ETF (EMQQ) vs EEM.
As an investor, relative performance matters. And, EMQQ is just a better index than EEM if making money matters. There are a few other choices out there, but I like this one for its liquidity, it’s rare I own an ETF with less than a billion dollars in it.
Currently, EMQQ is suffering a blood bath as China’s Xi embarks on homogenizing China and consolidating power. Eventually, money matters, and the basket of Chinese stocks in EMQQ will rise again.
Sometime soon, it seems like EMQQ will be a good buy. I’m targeting a price in the lower $40s, but if there is a deeper global shock, say China’s economy slowing even more, then we could see lower $30s I think. We have to play in real time and avoid trying to catch a falling knife, but we have some technical levels that we can watch to help put the odds and cost basis on our side.
Notice that RSI, MFI and CMF are not oversold yet on the monthly chart. That implies if a large correction develops, there is plenty of room to fall. We want to look at the weekly charts though for more likely support.
Here we see there is still downside on the weekly charts as well. Again, as position traders who measure our trades in quarters and years, we want to be patient.
I can not say this enough, I believe this is possibly the biggest investment driver of the next decade. If it’s not first, it’s close.
The recent IPCC (Intergovernmental Panel On Climate Change) made it very clear that mankind is driving climate change (read it before you opine contrary). What we know beyond the fact that we are impacting the climate dramatically, is that stabilizing the climate will take a very long time and if we don’t stop pushing the climate warmer we could literally wipe out most of humanity by the end of the century.
Yeah, that’s a pretty big deal.
As such, governments, corporations, foundations, institutions, money managers, family offices (think Rockefellers) and people who care are making massive shifts in their capital allocation.
We have governments writing policy that get rid of ICE vehicles, cut back on fossil fuel use, push technology that cuts pollution and increase building efficiency.
Corporations are moving towards renewable energy and sustainability in general.
Foundations, institutions, money managers and family offices are selling fossil fuel investments and buying clean energy and clean tech investments.
Now, I’ll stop here to say, it doesn’t matter what you believe about climate change. As an investor, you just need to understand how capital works.
It is clear, the trend is away from dirty, i.e. fossil fuels, dirty cement, wasteful agriculture and carbon intensive buildings and towards clean energy, carbon neutral agriculture, efficient industry and better buildings.
These are not cyclical or temporary trends. The shift is secular in nature and permanent. In other words, sustainability is now forever, even if it hasn’t quite reached the hockey stick up phase.
That’s where there is opportunity though. The post Covid crash rally in clean energy and other sustainability stocks was a glance at what is coming. Consider that only about 10% of energy is renewable, but that most energy will be renewable in our lifetime. That’s a lot left to go.
Sustainability is a clear buy the dips theme.
Is that clear enough? Let’s look at since Christmas Eve 2018 when the market bottomed from the 2018 corrections:
And, from the bottom of the Coronavirus Crash:
Get the drift?
As members know, I bought the Invesco Wilderhill ETF (PBW) in April 2020. I owned the Invesco Solar ETF (TAN) in years prior. I swapped to PBW for slightly better diversification and methodology vs pure solar. Performance has been similar despite the better risk profile, i.e. better risk adjusted return.
You can see on the weekly chart that PBW is flirting with my buy zone. I have a starter position, but am waiting to see if we get a price below $70 to add. I suspect we do. We might get lucky and get a price in the $50s. If we do, I will make this position as big as my QQQ position.
Growth here could be massive. But, volatility is still substantial. We can use that to our advantage with a slow handed scaling in approach.
Final Investment Thoughts
There are certainly other investments out there for us. For dividend investors we are buying fewer small caps and more large cap dividend stocks, including our 4 favorite REITs. Our trade alerts this week included two such companies.
But, as far as a general diversified investment approach goes, the three ETFs I covered today are a fantastic core asset allocation that can take up to 20-60% of your net asset value in a blended stock and ETF portfolio.
Because I usually have about 60-80% in stocks or cash holding cash-secured puts, I’ll tend towards 20-40% in QQQ, PBW and EMQQ combined, with some covered call and put writing on PBW and EMQQ.
The balance of my funds will be picking stocks. Depending on the type of investor you are, you can edge towards SMID caps or dividend stocks or blend there too.
Disclosure: I/we have a beneficial long position in the shares of PBW, BRK.B either through stock ownership, options, or other derivatives.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.