The stock market last hit a record on Aug. 7 and it’s been a good 3 weeks since we’ve seen a new high. As I write this, however, we are digging out of the hole and close to returning to the glory days. We’ve recently lived through a dip of about 2% and if you read the news at all, it’s as if we just saw a foreshadowing of the end of the world. So what’s going on in the market and what does this dip really look like?
Since the S&P500 peak on Aug. 7 dipped 2% and then came back up. Overall, this 2% dip is nothing but news fodder. I honestly can’t believe all the wailing & gnashing of teeth it has created. The 50 largest stocks in the S&P500 dipped an average of 1.66% while the smallest 50 stocks dipped an average of 4.52%. As has been the case all year, smaller companies are underperforming the larger companies in the indexes.
In dissecting this dip, I will say that it’s no surprise that the 50 stocks with the worst performance YTD pulled back and average of 5.05% while the 50 best performing stocks YTD only pulled back 0.33%. This hardly indicates any large-scale reversal or offers evidence that investors are “taking money off the table” in large fashion.
Can You Beat The Market?
As I’ve mentioned in previous ramblings, it’s hard to beat the market. Very hard. A vast majority of those who try (and those who may charge you a lot of money in their attempts) will fail. The S&P500 is what we consider our “market benchmark”.
The S&P500 represents a good 80% of the US stock market as a whole and as much as 48% of the sales to S&P500 companies are from outside of the US, making it true international barometer as well. It is the ideal “core investment” in any portfolio.
With the S&P500, the performance bar is high and difficult to clear. Let’s take a look at how we effectively can track it, and then how we may be able to beat it in an efficient, and relatively low-cost / low-risk manner…
SPY – SPDR S&P 500 ETF – Tracking The Index
The S&P500 index is weighted by the market capitalization (size) of the companies in the index, and it is ubiquitously tracked by the SPY ETF. Currently, with Apple being the largest company in the world, it carries the top weighting in the index (3.98%) with News Corp B being the smallest of the S&P500 companies (0.007%). That means $100 invested in an S&P500 index fund like SPY would buy you $3.98 worth of Apple and $0.007 worth of News Corp B. As it tracks the S&P500, SPY is the ETF that sets the mark to beat.
RSP – Guggenheim S&P 500 Equal Weight ETF
One strategy to beat the SPY, one that is very attractive to me, is an equally weighted fund like RSP. In this ETF each stock of the S&P500 is equally weighted at .2% instead of being weighted by size. This means if you drop $100 into RSP you will buy 20 cents worth of each of the 500 stocks. This is going to give you a significant tilt toward smaller and middle weight companies as you’ll be buying a lot more shares of the smaller 100 or so companies and lot less shares of the largest 100 or so companies relative to an S&P index fund weight by market capitalization (size) like SPY.
As mentioned earlier, smaller companies are underperforming this year. That means RSP, with its smaller company tilt, is underperforming SPY this year as well, trailing it by about 2%. However, over the past 10 years RSP has outperformed SPY, as the chart above will indicate.
PRF – PowerShares FTSE RAFI US 1000 Portfolio
Another strategy is a “smart beta” fund like PRF. This is a fund that combines passive indexing strategies with a screening algorithm that aims to maximize your reward against the amount of risk you take in the the investment. PRF buys 1,000 stocks and ranks them not based on size or equal weighting, but on four fundamental measures (book value, cash flow, sales, and dividends). This fund puts Exxon at its #1 weighting (2.65%) and Apple #2 (2.41%) and takes you all the way down to California Resources Corp (0.01%) as its smallest holding.
Like RSP, PRF has trailed the S&P500 this year (by 5.23%) but over the past 10 years it has outperformed the SPY, yet it has trailed RSP as the chart above will show.
Yields: SPY @ 1.88%, RSP @ 1.19%, and PRF @1.89%
Expense Ratios: SPY @ 0.09%, RSP @ 0.20%, and PRF @ 0.39%
Protecting Your Downside
If you feel like you need some downside protection in your portfolio you can do a few things to help ease the pain of any broad dip in the market. One, simply keep 12 month’s worth of expenses as cash in your portfolio. Two, move an additional 2 to 4 years worth of expenses into short-term bonds or TIPs. Three, consider a “basket” of higher dividend stocks and real estate investment trusts (REITs) to spike income. Four, check your allocation of stocks to bonds – if you were 80/20 in 2010 you could very well be 90/10 today after our huge market run. Make sure you are well diversified and properly allocated. One good number is 120 (minus) your age for your stock allocation. At 49 years old that puts me around 70% stock to 30% bond – not a bad place to be though I am much closer to 80/20 in all honesty.
Remember, not every stock downturn is Armageddon like we saw in 2008. Over the past 50 years, the average downturn in the S&P500 has lasted about 36 months. Also, keep your long range plan in view. If you are nearing retirement, a 3 year dip could cause concern and you’d want to be sure you have that downside protection I mentioned earlier built in. You don’t want to have to sell off equities for cash to live on when those equities are down 10-20%, so have that cash and that short-term bond or TIPs money allocated to prevent forced selling of your equities into a bear market. This will allow to cash out when you want to (at higher market prices) and not when you have to.
If you’re 30 years old and 30 years from withdrawing money from your Roth, then I have no idea why you’d be worried about anything the market is going to do over the next 20 years. You should just turn off CNN and keep investing at regular intervals. If anything, use dips in the market to amp up your investing. Buy low, sell high…
More dips in the S&P500 are coming. No one can say exactly when. There’s all kinds of warnings, signs, signals, charts, graphs, pontifications, and Nostradamus-type predictions you can choose to heed or ignore. I will choose the latter, but I will keep me eye on a few things near term:
- Everyone on Wall Street (it seems) vacations in August. With your hard-earned money they’ve bilked from your accounts, they hit the beaches in The Hamptons, Cape Cod, Grand Cayman, and St. Tropez. They’ll drag back into their offices after Labor Day ready to prove their worth once again. Prepare for more market volume & more volatility when they fire up their trading terminals. If you like fireworks consider TVIX, but DO NOT hold that sucker overnight. Wait… forget I said that – stay away from it. Trading volatility is like playing with a Roman candle at an Exxon station.
- Hurricane Harvey. At $190B in damages with 80% of it as uninsured losses this will have an impact on economies in Texas that are quite large and will effect the supply chain of the entire country. It could also be a means to prosper in the market as well if you choose your investments wisely and back they key players. Take a look at oil & timber ETFs and companies that provide important infrastructure and major manufacturing parts and services, especially to the oil and refinery industries. The WOOD (timber & forestry) ETF us up 2% in the past 2 days and pays a 1.5% dividend. BNO (Brent Crude Oil) is up over 4% in the past 2 days as well.
- Interest Rates. More bumps in interest rates are imminent and their imminent effect on the bond market cannot be denied. Interest rates have been abnormally long for far too long and there’s only one way for them to go. Remember as rates rise, bond prices sill fall and their yields will increase. A sharp uptick in interest rates could expose the bond market as a “bubble”. Keep your bond durations shorter and consider mortgage-back securities that will be better insulated against moves in interest rates. I like TOTL (or DLNTX, its mutual fund equivalent) and PONDX in the bond space.
- The Federal Reserve. When these guys start trying to unload QE assets from their books no one knows what’s going to happen. We’ve never tried to move $4Trillion worth of fake money around. Yes, that’s $4Trillion. I don’t know how to invest around that kind of Monopoly game…
Like the coffee mug says, kept calm and carry on. Sh[t]uff happens. Markets dip, and they ebb and flow. Don’t get sweaty when they drop 2%, that’s ridiculous. Stay allocated, stay committed, and stay long term goals. Cheers!
I work for Apple and I own Apple stock. It is mentioned in this blog merely as a component of the S&P500. I am not recommending you invest in any security mentioned. After doing your own due diligence, you should consider consulting the services of a trusted, fee-based advisor before investing in anything. The opinions expressed here are my own and do not represent my employer.