ETF Review and Outlook
DIA, SPY and QQQ
By contrast to received wisdom, the financial forum is entwined with the real economy not only in the future but also the present which happens to spring from the past. In view of the jumbling, the mindful investor has to examine the landmarks in the backward direction as well as the outcrops in the current environment in order to sketch out the conditions downstream.
Moreover, the course of the markets going forward depends on the forces at work today along with the contours of the landscape downrange. For this reason the survey here draws partly on, and fleshes out, the drivers at this juncture as well as the conditions in store over the coming year and beyond.
From a practical stance, the companies listed in the stock market earn their living within the economy at large. That much is true even in the case of virtual firms such as online retailers and brokerage houses. As a result, the aggregate level of economic output plays a vital role in corporate earnings and thus the price movements on the bourse.
Within the tangible economy, the conditions have not changed a great deal over the past few years. On the downside, the politicians of the West have gone out of their way to solidify the distortions in the housing sector in the wake of the financial crisis of 2008.
A showcase involved the prop-up of some of the biggest and most unproductive firms in the economy. In particular, trillions of dollars round the world were shunted into bailouts for a gaggle of gutted banks that had succumbed to their own reckless schemes.
To make matters worse, the struts erected have prevented the property market from shedding the mountain of blubber it had built up during the anic bubble in real estate prior to the financial blowup. Due to the shackles in place, the economy as a whole has been doomed to gasp and limp well into the 2020s.
In this shaky environment, the prospects for the industrial nations are lackluster at best. A glaring example lies in Europe, which continues to wallow in the doldrums. Given the torpor of the rich countries, the emerging markets round the world will have to slog ahead amid the general weakness in the global economy.
On a positive note, though, the U.S. has begun to recover somewhat from the disruptions caused by the housing craze and its aftermath. The mangling of the markets during the bubble was compounded by a raft of knee-jerk reactions by impulsive politicians, as in the likes of lifelines for ruined banks along with crutches for real estate. After stumbling for half a decade in the aftershock of the Great Recession, the U.S. economy has finally taken a few faltering steps toward regaining its health.
On the political front, 2016 happens to be an election year for the U.S. presidency. As the race heats up, the air will crackle with the platitudes and promises of politicians in their zeal to beguile voters by ranting about the desperate need to create jobs and boost incomes, bolster business and lavish favors on one and all. The whirl of bluster will kindle a spark of hope amongst large swaths of the populace and imbue the listeners with a warm, fuzzy feeling. Moreover a binge of wanton spending is apt to give the economy a boost over the short run despite the exorbitant cost to the society over the longer range.
In the financial forum, the stock market often anticipates the real economy by half a year or so. For this and other reasons, the American bourse in particular is poised to head higher as the year rolls on.
The buoyant tenor of the election year, coupled with the stagnation of the bourse over the past year, provides the backdrop for a moderate advance. As a result, the Dow yardstick may by the second half of 2016 surge by 20% or more on a short-lived basis.
On the downside, though, the main cumbrance is of course the precarious state of the economy. The chains of production and distribution were bent severely out of shape amid the riot of speculation during the housing frenzy prior to the financial crisis of 2008, followed by the orgy of government spending and money printing in the years to follow. Given the breadth and depth of the traumas, the economy is only now starting to take some feeble steps toward recovering in earnest from the gross abuse it received at the dawn of the millennium.
To recap, the politicos will make a lot of noise about boosting the economy in the run-up to the elections in November. Regardless of the substance – or lack of such – behind the clatter, the happy talk will shore up the spirits of millions of voters and investors. As a result, the market should follow its custom of crawling higher as the winter draws near. From a larger stance, the election year tends to be a peppy portion of the four-year Presidential cycle.
As is often the case at the beginning of the year, the market will thrash around more than press ahead during the months of January and February. After the splash of turmoil, however, the bourse should muster the energy to press ahead by a modest amount.
In the months to come, the market will waddle higher as the temperature rises. In the spring, the first task for DIA is of course to regain the peak at the $180 level which was formed last year. After that stage the subsequent milestone lies at $190, a marker which should be reached by the summer.
Then comes the usual tumult around the middle of the year. On a positive note, though, the Olympic Games will take place for several weeks in August. At that stage, the general air of festivity and goodwill round the world will cast a warm glow on the stock market as well. For this reason, the bourse will be more upbeat than usual for that time of year. As a consequence, the Diamonds are slated to reach and even surpass the landmark at $200.
After forming a crest, the market will slump as usual in the autumn. The comedown will be followed by a reluctant recovery as the year draws to a close.
Looking at the big picture, the leading benchmarks of the bourse face a series of big challenges over the year to come. Some of the stumpers have nothing to do with the substance and reality of the marketplace yet everything to do with the perception and bias of the actors involved.
For one thing, the Dow index faces a monumental wall at the 20,000 level. When the beacon reaches the landmark, the market will duly break down. The jarring crunch should amount to a sizeable drop toward the threshold of 15% that marks a full-blown crash of the stock market in the U.S.
In the most likely script, the market will bump up against the wall at 20,000 points a couple of times before breaching it on the third try. The travails of the Dow will of course be mirrored by the DIA which will have to grapple with its own hang-up at the $200 mark.
Even so, the Diamonds are likely to surpass the totem at the $200 level by the second half of this year. After reaching the subsequent milepost at $210, however, the index fund will fail to hold onto the prize. Instead the market will fall back promptly then flail around for a few months.
When it retreats, DIA will return to the watershed in the $200 zone in short order. That backtrack should occur by the time next winter rolls around.
The Diamonds closed out 2015 at a price of $173.99. In that case, the watershed at $200 represents an increase of 15%. The latter figure is the default target for the end of this year in spite of – and due to – the gyrations along the way.
In addition to the circle of 30 titans tracked by the Dow index, another leading benchmark lies in the troupe of 500 giants monitored by the Standard & Poor’s company. The yardstick is tracked by an index fund which runs under the banner of SPY.
Meanwhile the third beacon of the bourse deals with the Nasdaq market. On this exchange, a broad-based yardstick known as the Composite Index is widely reported by the financial media. On the other hand, a subset of the market made up of a hundred giants is the mainstay for practical investing. The tracking vehicle for the Nasdaq 100 Index – also known by the nickname of NDX – is found in QQQ.
This report examines the special aspects of SPY and QQQ which distinguish their prospects from the agenda for DIA. Moreover a detailed forecast of each of the broader benchmarks is provided.
To round up, the trio of stalwarts for the U.S. bourse will tramp onward and upward through a series of zigzags as usual. The story will unfold in a similar fashion for the other stock markets round the globe.
Although there are plenty of exceptions, the bourses of the budding regions often advance roughly twice as much as the Diamonds or Spyders. In that case, an upswell for DIA ought to accompany a lively surge for the emerging markets.
On a negative note, though, the feisty markets also tend to be the most flighty. To bring up another needler, the mass of investors remain somewhat skittish. As a result, the international crowd may well refrain from moving en masse into the sprouting markets until the end of the year or thereafter.
The task of forecasting this year poses a case study of uncommon complexity. For starters, the forces in play include a host of routine drivers as well as wayward factors. An example of a commonplace theme lies in fundamental drivers such as business conditions and monetary policies in the real economy, or technical features as in seasonal patterns and multiyear trends in the financial realm.
To add to the muddle, though, a bunch of issues crop up only once in a few years or even decades. An example of the former is the weighty impact of the political theater on the stock market due to the election cycle in the U.S. Meanwhile an instance of the latter is the psychic barrier posed by a towering landmark that arose in the throes of an epic bubble in online commerce on the eve of the millennium.
On the upside, the hoopla on the political front will infuse hordes of investors with hopeful views on the real economy along with the stock market. On the downside, though, a gauntlet of mental roadblocks will hamper the madding crowd and prevent the bourse from gaining its stride. In line with earlier remarks, an example lies in a hulking barrier for the Dow index at the 20,000 level. Another sample is a dual barrier against the Nasdaq 100 Index due to its historic peak at 4,816.35 points forged at the height of the Internet craze, followed by a mental block at the glaring landmark of 5,000 points.
Given the lineup of stumbling blocks, the stock market is destined to flounder even more than usual during the second half of the year. Along the way the leading benchmarks of the bourse will suffer a series of thumping flops. The drubbing will of course be worse for the minor leagues as in the case of bantam stocks or emerging markets.
Amid the pother, the swarm of international investors will continue to fret over the drab conditions in the mature economies. An example involves the quagmire in Europe resulting from the housing bubble, followed by a raft of witless schemes ranging from the prop-up of real estate to the rescue of braindead banks from their own rabid bets.
Another instance concerns a lavish policy on mass migration. A good example is the intake of refugees at the rate of millions per year by Germany and Sweden, along with the upkeep of the asylees in motley ways ranging from cash stipends and paid housing to gratis healthcare and free education. The upshot is a crushing burden which will amount to trillions of euros over the decades to come. The millstone will cripple not only the Teutonic countries but hamper the entire continent and even the global economy to some extent.
On the financial front, one way to predict the course of SPY and QQQ is to consider their relative motion in comparison to the DIA fund. For this purpose, the standard approach taken by the financial community lies in the beta factor. The latter quantity, however, happens to be a misleading and problematic gauge for the genuine investor focused on the long range.
For this reason, we rely instead on the actual value of the scaling factor over a fitting timespan rather than lean on the beta coefficient along with its unrealistic assumptions and predictions.
Over the course of 5 years ending in early 2016, the Diamonds turned in a capital gain of 34.80%. Meanwhile, the corresponding returns for the Spyders and Qubes were 46.23% and 89.01% respectively.
Based on the first two values in the preceding paragraph, the scale factor for SPY compared to DIA was 46.23/34.80, which comes out to some 1.33. By contrast, the effective value of the scaling factor for QQQ amounts to 2.56.
According to this approach, the final outcome for SPY at the end of this year lies roughly 33 percent higher than the closing payoff envisaged for DIA. As we noted earlier, the mostly likely turnout for the Diamonds lies 15% beyond the terminal price it reached last year. In that case, a surfeit of 33% means that the corresponding target for the Spyders amounts to an annual gain of 20% over the course of 2016.
We can perform a similar calculation for the Qubes. The product of 15% for DIA and the scaling factor of 2.56 for QQQ comes out to roughly 38%.
On one hand, the latter value does lie within the realm of possibility. Even so, the lofty target seems far-fetched in view of the barricades along the way. As we noted earlier, an example in this vein is a mental block at the towering peak formed at the height of the Internet craze at the turn of the millennium.
In the height of the digital bubble, the Qubes formed a peak at a nominal price of $232.88. On the other hand, the latter price has to be halved in order to compensate for a stock split of two shares for one during the second half of March 2000. In that case, the corresponding price today happens to be $116.44.
The Qubes came within spitting distance of the latter landmark when it reached $115.75 in December 2015. But the hustler fell back promptly and closed out the year at $111.86.
From the latter baseline, a ramp-up of 38% would take QQQ to $154.37 over the course of 2016. On one hand, the latter peak could well be reached by the second half of this year. Even so, the Qubes are unlikely to end the year on such a high note.
For starters, QQQ has yet to surmount the massive barrier at the split-adjusted price of $116.44 reached at the height of the Internet froth in spring 2000. Moreover, the index fund is apt to challenge the landmark at least a couple of times more before it breaks through in a decisive fashion.
Under these conditions, the Qubes are much more likely to hover around the $140 level as the year draws to a close. The latter value represents an upturn of 25% beyond the price of $111.86 set at the end of 2015.
We now return to the raw benchmarks within the Nasdaq market. As a backdrop, the Composite index reached a zenith of 5,132.52 points in March 2000.
Over the past year, the yardstick pushed a bit beyond the historic landmark when it touched 5,231.94 units in July. After forming the peak, the index was bound to fall hard – which it did.
By comparison, the Nasdaq 100 index soared to 4,816.35 points in March 2000. Over the past year, though, this benchmark managed only to reach a high of 4,694.13 units in July. But the NDX had to fall back since the broader Composite had hit its own ceiling and was obliged to take a dive as a result.
Even so, the NDX – unlike the Composite – still had room to run before it reached its own historical peak set in 2000. For this reason, the leaner index formed a higher apex at 4,739.75 points in December 2015.
Despite the latest peak for NDX, neither of the Nasdaq benchmarks was going to push past their watersheds in a forceful fashion anytime soon. One consequence was a harrowing plunge for the entire bourse before and after the turn of the year as 2016 rolled around.
To sum up, each of the gaudy peaks set at the height of the Internet bubble has acted as an attractor: a point toward which a system within the vicinity tends to move. After forming a trough in 2002, the stock market propelled each of the leading benchmarks higher for a handful of years. The story was similar after the bust of the housing bubble followed by the financial flap of 2008. As an example, the Nasdaq 100 index has in recent years been rushing toward its all-time peak at a brisk pace.
A series of landmarks were reached as expected over the course of 2015. Looking downrange, each of the prior peaks will continue to act as an attractor in a negative sense by posing as a deadweight or a blocker against further progress. For instance, the underlying benchmarks of the Nasdaq will lurch back and forth across their all-time highs over the year to come and likely even longer.
The antics of each index will of course be mirrored by its tracking fund. As an example, QQQ is slated to advance beyond its prior summit during the first half of this year but is unlikely to breach the ceiling in a substantial way anytime soon.
In these ways, the trio of index funds for the U.S. bourse will tramp onward and upward through a series of zigzags as usual. The story will unfold in a similar fashion for the other stock markets round the world.
Although there are plenty of exceptions, the bourses in the budding regions often advance roughly twice as much as the Diamonds or Spyders. For instance, an upturn of 15% for DIA should result in an uplift of 30% or so for the frisky markets.
On a negative note, though, the callow benchmarks also tend to be much more volatile than their American counterparts. Meanwhile the mass of investors remain somewhat skittish at this stage. For this reason, the international crowd is likely to hold back rather than rush into the emerging markets over the year to come.
On the bright side, the emerging regions generate the bulk of economic growth for the world as a whole. Sooner or later, the superior performance of the dynamos in the tangible economy will attract a tidal wave of capital into the blooming countries.
An inrush of mint could perhaps begin within a couple of years. In that case, the bourses of the flowering regions will snap out of the funk of the recent past and revert to their habitude of trumping the benchmarks in the mature countries. Given the mondo problems in Europe and elsewhere, however, the comeback of the emerging markets with the zest they deserve may have to wait another few years or more.
NOTE: The full report is a document in PDF form. The fresh update of the report, titled “Forecast of Top Index Funds for Investing in the Stock Market”, may be downloaded from the Library at MintKit Core.