Large Shifts Below Surface of S&P 500 Index

06/23/2017 2:55 am EST

Focus: STOCKS

Marvin Appel

President, Signalert Asset Management LLC

State of the Market:  S&P 500 Index holds it ground near record highs while international equities soften.  Our U.S. equity models remain overall neutral-bullish, asserts Marvin Appel, MD, PhD. He’s president of Signalert Asset Management LLC.

The S&P 500 Index, a broad representation of large U.S. companies, has stayed within a narrow range over the past three weeks despite touching a new closing high on June 19. But this quietude masks a number of large shifts beneath the surface.

Foreign stocks have turned down in June.  For example, the iShares MSCI EAFE Index ETF (EFA) penetrated its lower Bollinger band for the first time since November.  MACD is below zero and falling, as shown in the chart.

chart 1

The top part of the chart shows the ratio EFA/SPY.  When this ratio is rising it means that EFA (representing developed-country foreign stocks) is stronger than the S&P 500 Index, and vice versa.  In November, the S&P 500 Index far outperformed foreign stocks.  But from late December until mid-May, EFA recovered its relative strength.  The iShares MSCI Emerging Markets Index ETF (EEM) is showing a similar pattern.

Does this mean that foreign equities have had their day? I continue to expect foreign equities to outperform U.S. equities on a multi-year basis.

A further pullback in EFA would likely represent a buying opportunity:  $62.50-$63.50 is a potential support area.  If EFA pulls back to $63.50, I would recommend writing covered calls that expire on 1/19/2018.  With EFA at $64.98, $65 calls are $2.49 bid.  The maximum total return from a covered call position over the next seven months until expiration would be 3.8% for the call and a likely 1% dividend in December. If EFA pulls back to the support area, the call premiums would likely be even higher.

chart 2

Consumer Staples (XLP)

In May it appeared that the Consumer Staples Select Sector SPDR (XLP) was poised to outperform the market, but that trade has been a disappointment.  One problem was the Amazon (AMZN) takeover of Whole Foods, raising the specter of new competitive pressures facing much of the consumer staples sector.

The XLP chart shows that XLP has retreated to the lower Bollinger band where, I expect, it should hold support.  Consumer staples companies tend to be large multinationals with much of their earnings derived from foreign sales. As a result, XLP took a hit compared to the S&P 500 after Trump’s election, as he was viewed as unfriendly towards trade.  Since the election, XLP and SPDR S&P 500 ETF (SPY) have performed mostly in tandem.  (See XLP/SPY in the chart.)

chart 3

Long term, XLP is at a relative strength low compared to the S&P 500 Index. The golden age for consumer staples was during the crash of 2008. Since then, consumer staples stocks have alternately led or lagged the S&P 500 with no clear trend emerging over the past eight years. Market history since 2009 suggests that XLP should regain its footing. 

I continue to recommend XLP as a long term holding because of its history of below-average risk during major market declines.

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