Nobody to Blame But ETFs

Jim Woods

The market’s resilience in 2017 is indeed remarkable.

Consider that we’ve only hit a few speedbumps all year on the road to a series of new-high mile markers. One of those speedbumps was hit Tuesday, as market leadership in the large-cap tech issue helped the NASDAQ Composite crumble some 1.6% in the session.

Yet today, stocks have rebounded nicely. The NASDAQ is up 1.2% leading up to Wednesday’s final hour, and many leading sectors, such as semiconductors and super-cap internet stocks, were spearheading the bullish charge.

As for Tuesday’s pullback, that had a lot to do with the surprise move by the Senate to shelve the health care reform bill, at least for now. The market looked at that as a sign that President Trump’s pro-growth agenda was in jeopardy.

Yet while I think any big health care legislation may be in trouble, the market still is hopeful that tax reform can be done by early next year. As long as that hope remains alive, the resilient bullish tailwind likely will blow through the corner of Wall and Broad.

Of course, this rally isn’t just about hope. It actually is more concrete than that. In fact, if you’re looking for someone, or something, to blame for 2017’s surge in stocks… well, just blame it on exchange-traded funds (ETFs).

According to just-released data from the Federal Reserve, ETFs bought $98 billion in U.S. stocks during the first three months of this year. That number, as the Wall Street Journal points out, is on pace to surpass their total stock purchases for 2015 and 2016 combined. In fact, the data shows that ETFs owned nearly 6% of the U.S. stock market in the first quarter, their highest level on record.

Interestingly, there’s a lot of us in the investment advisory business who have scrambled to explain the relentless move higher in equities in 2017. Some, as you’ve just seen, like to blame ETFs. Others like to blame the hope trade still present from President Trump’s pro-growth agenda. Still others blame the improved corporate earnings environment for the equity bull’s run.

I think the answer is it’s a combination of all these reasons. Plus, there’s also the fact that stocks still represent the “TINA,” trade, i.e. “There Is No Alternative.”

So, blame it on ETFs, blame it on hope, or just blame it on TINA. Either way, if you’ve missed this rally, well, you’ve got no one to blame but yourself.

If you’d like to get on board this rally with a proven, four-decade “safety net” in place to tell you when it’s time to get out of stocks, then I invite you to check out my Successful ETF Investing advisory service, right now!

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ETF Talk: Drone Exchange-Traded Fund Soars to New Heights

The exchange-traded fund PureFunds Drone Economy Strategy ETF (IFLY) focuses on the emerging commercial drone market.

IFLY invests in global equities related to the drone industry, including manufacturers and suppliers. Drone technology has risen to the forefront of public awareness in the last few years.

Although the first drone was built and used as early as 2002 by the CIA, the entire industry has been relatively unknown to the public. Even since the beginning of drone usage, they largely have been the stuff of science fiction. News coverage on drones predominantly has been on recreational use by consumers and enthusiasts.

As drone technology enters a cycle of ballooning growth, it is finding applications across many industries such as agriculture, construction and utilities for purposes that were nearly unimaginable 10 years ago. In the construction industry, for example, the current value of labor and services provided by drones is estimated to be $127.3 billion.

To help you get an idea of the big names that are actively participating in the drone business, here are some noteworthy events that took place this year: Qualcomm’s launch of the Snapdragon Flight Drone; Google’s plan to use solar-powered drones to spread Wi-Fi; and Amazon’s plan to use drones to speed up delivery of consumer packages.

As a new and attractive industry, drones also have some weaknesses, including a lack of thorough regulation and big players to push the industry forward. It will become easier to predict the industry’s movements once these weaknesses are addressed, at least to some extent.

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IFLY has $15.41 million in total assets under management, with roughly 53% invested in U.S. companies and 42% in a variety of European and Asian companies. IFLY itself has a global scope and considers all areas of investing, including emerging markets, to be fair game. Although this means that it falls below my recommended threshold for investment, the fund’s interesting strategy is nonetheless worth bringing to your attention.

Since its inception in March 2016, IFLY’s net asset value (NAV) has increased by 25.76%. Year to date, IFLY has returned 16.01%, beating the S&P 500’s return of 8.79%. IFLY has an expense ratio of 0.75%.

The fund has a total of 44 holdings. The top five are Parrot SA, 9.23%; Boeing (BA), 4.65%; GoPro Inc. (GPRO), 3.69%; Ambarella Inc. (AMBA), 3.31%; and Thales Group, 2.12%.

If you believe in the expanding applications of drones in the future, I encourage you to look into PureFunds Drone Economy Strategy ETF (IFLY).

As always, I am happy to answer any of your questions about ETFs, so do not hesitate to send me an email. You just may see your question answered in a future ETF Talk.

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ETFs & the Music of the Markets, Part I, II, III

Over the past several weeks, we’ve presented our three-part series on ETFs & the Music of the Markets. Here’s a compilation of all three parts, as many readers have asked me to put them all together in one place. Hey, you asked, and we listened.

Part I (June 7)

What do exchange-traded funds (ETFs), music and the markets have in common? Well, aside from the fact that I happen to love them all, ETFs, music and the markets have a lot in common.

Here’s a little analogy to help illustrate my point.

Remember the 2004 biopic “Ray” starring Jamie Foxx in the lead role as Ray Charles? I suspect you may have seen it, and if you haven’t, I highly recommend it. Foxx won an Academy Award for his portrayal of the great singer, songwriter and pianist, and the film was a no-holds-barred look at Charles’ life.

In preparing for the film, Ray Charles sat down with Jamie Foxx, who also is a classically trained pianist, to play the piano together and exchange musical vibes.

Here’s how Foxx described the encounter in an interview with best-selling author and podcaster Tim Ferriss.

“As we’re playing, I’m on cloud nine. Then he [Ray Charles] moves into some intricate stuff, like Thelonious Monk. I was like, ‘Oh Sh*t, I gotta catch up’ and I hit a wrong note. He stopped because his ears are very sensitive: ‘Now, why the hell would you do that? Why you hit a note like that? That’s the wrong note, man.’ I said, ‘I’m sorry Mr. Charles,’ and he said, ‘Let me tell you something, brother. The notes are right underneath your fingers, baby. You just gotta take the time out to play the right notes. That’s life.’”

Wow, that is life, indeed.

When applied to investing, we also can say that the music of the market also dictates that we “take the time out to play the right notes.”

You see, the proliferation of ETFs over the years also has put the “right notes” underneath our fingers. In fact, today we can literally get portfolio exposure to just about any segment of the market by tapping on the computer keyboard that’s right underneath our fingers.

And while doing this right may be easier said than done, it can and is being done by all sorts of investors, worldwide.

Of course, the key to becoming a good musician, and to knowing the right notes to play, takes a whole lot of deliberate practice, knowledge and cultivated skill. It’s the same way with investing.

Part of our mission here in the Weekly ETF Report is to help you acquire the knowledge and the skill to be able to play the right notes in your portfolio.

In the weeks and months to come, I will be showing you my techniques to help you identify the right notes when it comes to selecting winning ETFs for your portfolio.

Many of these techniques are at the heart of the proven, trend-following investment plan that’s helped investors preserve and grow their capital for over four decades in my Successful ETF Investing advisory service.

Part II (June 14)

One of the beauties of exchange-traded funds (ETFs) is that they allow us to hear the “music of the markets” playing out in real time. This week, we’ll look at that music a bit, especially in light of today’s “dovish hike” by the Federal Reserve.

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This is Part II of our series on ETFs and the Music of the Markets, so let me remind you what I wrote in Part I. First, we used the great Ray Charles’ words, as he once said that if you want to make the right music, “You just gotta take the time out to play the right notes…”

Simple enough, right? Only, not so much.

Still, when applied to investing, we can say that the music of the market also dictates that we “take the time out to play the right notes.”

Fortunately, the proliferation of ETFs in recent years has made playing the right notes a lot easier. Today, we can literally get portfolio exposure to just about any segment of the market by tapping on the computer keyboard right underneath our fingers.

Last week, I also told you that part of our mission here in the Weekly ETF Report is to help you acquire the knowledge and the skill to be able to play the right notes in your portfolio.

Well, we just had what may have been the most important Federal Reserve Open Market Committee meeting (FOMC), as today’s Fed decision will likely set the playing field for stocks and bonds going forward.

Before the meeting, the smart money was betting on (i.e. pricing in) what’s called a “dovish hike” by the central bank. This is a situation where the Fed would hike interest rates by 25 basis points, but also make the statement “dovish” enough that it doesn’t cause long-dated Treasury bond yields to rise… and that’s precisely what happened today.

The Fed did hike rates 25 basis points, and bond yields did fall. In fact, the benchmark 10-year Treasury yield fell sharply, down below 2.14%.

This is important, because it’s a problem for stocks long term. The reason why is that this market’s record-high rise has been fueled by the “reflation trade.” That means the market is expecting faster economic growth, and more inflation. Yet a stronger economy is not being reflected in bond yields, which should be rising.

Also, the Fed admitted today that inflation is running below its 2% target rate. Yet the Fed still felt it could hike rates, and also begin the process of “normalizing” its balance sheet. “Normalizing” the balance sheet is Fed speak for “reducing Treasury holdings.” The Fed did announce its plans to do just that, even issuing an addendum to the FOMC statement outlining just how it would normalize that balance sheet.

The bottom line here is that the Fed did pretty much as expected with its “dovish hike.” And we know that because stocks did rise, albeit slightly, with the Dow Jones Industrial Average hit an all-time closing high, which can be seen here in the chart of the SPDR Dow Jones Industrial Average ETF (DIA).

Now that the Fed is out of the way, so to speak, it will be interesting to see how other market sectors react in the days ahead.

Sectors such as the aforementioned Treasury bonds, gold, and various interest-rate sensitive sectors such as utilities, financials, defensive stocks and REITs will be the key segments to watch in the weeks to come.

In Part III of our series, we’ll take a look at what’s happened in the wake of the Fed decision, and we’ll do so by listening to the music in the ETFs that play these various sector notes.

So, stay “tuned” (pun intended).

Part III (June 21)

I love music, and I love exchange-traded funds (ETFs). Both allow us to hear the “music of the markets” playing out in real time. In our third and final installment of our series, ETFs & the Music of the Markets, we look at the tune being played in two sectors leading the market rally… semiconductor ETFs and large-cap Internet ETFs.

Since the election, one of the key drivers of this market rally has been momentum. In the market version of Newton’s first law of motion, a market in motion to the upside tends to stay in motion… that is, until the market leadership falters.

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Given this market law of motion, it behooves us to listen to the music of the markets by listening to the action in top-performing market sector ETFs. Two of the best performers over the past eight months are semiconductor stocks and large-cap Internet stocks.

The ETFs pegged to these respective spaces are the iShares PHLX Semiconductor (SOXX) and the First Trust Dow Jones Internet ETF (FDN).

A big part of my job as your Weekly ETF Report and Successful ETF Investing editor is to look at sector trading every single day, because every significant market rally is driven by a few leadership sectors capturing the bulk of the “smart money.”

Yet when these leadership sectors falter, that usually implies an impending loss of momentum… and a potentially sharp pullback in the wider markets.

Since late 2016, semiconductors have been the biggest leadership sector in the markets. They rallied big during the fourth quarter 2016, and they are up big so far in 2017 (SOXX up 19.8%).

And while other sector leadership shifted from late-2016 and early 2017 (small caps to utilities and consumer staples), semiconductors have continued to ring out the bullish notes.

As for large-cap internet stocks, it’s no surprise that nearly half of the 2017 S&P 500 rally can be attributed to just a few stocks: AAPL, AMZN, MSFT, FB and GOOGL. And, it’s not a coincidence that those stocks are heavily weighted in the super-cap Internet ETF FDN.

Interestingly, the sell-off in both SOXX and FDN on Friday, June 9, was the first real sign that these two market leaders were capable of hitting a wrong note.

Since then, both have resumed their upward trajectory, and both mostly recovered from that tough, one-day sell-off. (Note, the selling in these sectors ramped up again on Tuesday, June 27. But the following, Wednesday, June 28, both sectors have come back strong). Yet it’s important to listen and watch the action in these two key sector ETFs, as another serious breakdown will imply a loss of momentum.

For now, the uptrends in SOXX and FDN remain intact, but I’ll be listening carefully for notes indicating the bullish song is over.

If and when I hear it, you’ll be the first to hear it from me!

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On Avoiding Investor Overconfidence

One of the biggest mistakes investors make, especially during bull markets hitting all-time highs, is to become overconfident.

This mistake has many pitfalls, including thinking you’re smarter than the markets, and failing to see that a decision you’ve made might not be correct.

Avoiding this negative influence on your investing results is the subject of an article in U.S. News & World Report titled, “The Dangers of Being an Overconfident Investor.”

I point this article out not just because it’s a very good read, and has very helpful hints on avoiding overconfidence. It does. I point the article out because I am quoted extensively in it, offering up my thoughts on getting past the all-too-human tendency to allow yourself to be overconfident.

If you’ve ever experienced a market loss due to overconfidence, or if you just want to avoid ever doing so, this article is a must.

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Friedman’s Prophecy

“Nothing is so permanent as a temporary government program.”

–Milton Friedman

The health care reform debate, and particularly the failure of the Senate to even bring its current bill to a vote, has confirmed the great economist Milton Friedman’s prophecy regarding government programs. At the heart of the reform issue is the proposed reduction in annual Medicaid spending (not an actual cut, as many in the media have said).

Here, even the hint of a slowdown in the growth of government spending is considered by some the height of “mean.” I see this as verification of Friedman’s proclamation that when it comes to a government program, it’s tough to ever get to where we were before said program existed. Get citizens hooked on Big Brother, and they’ll clamor for his protection regardless of the wider implications for society. Sad, but true.

Wisdom about money, investing and life can be found anywhere. If you have a good quote you’d like me to share with your fellow readers, send it to me, along with any comments, questions and suggestions you have about my audio podcast, newsletters, seminars or anything else. Click here to ask Jim.

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