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Friday, November 11, 2011
EQUITY ETFS HAVE A BREAKOUT WEEK – WILL NEXT WEEK BE THE UGLY SHAKEUP?
Just when it looked like Europe was falling apart last Wednesday, markets somehow managed to finish the week on a high note, as the S&P 500 increased 1.95% today.
European indices also had a big day, especially the DAX, which rose 3.22%. Furthermore, the VIX retreated but stayed just above the 30 mark, indicating that there is still plenty of risk lurking in the markets.
In commodities, oil and gold gained 1.29% and 1.72%, respectively. With all the volatility in equities, gold has held its own and will likely continue to remain attractive if equities dive once again.
There seems to be a market sentiment downplaying European risk, which I don’t agree with whatsoever. As reiterated by Federal Reserve vice chairman Janet Yellen, the U.S. economy is still significantly linked to European banking institutions. A financial setback in Europe can easily impose severe stress to the U.S. banking system.
Italy today passed an austerity measure to reduce its debt load, although this doesn’t bode well for the country’s growth prospects. Italian bond spreads are still incredibly high relative to comparable German bonds and the transitional government, once Berlusconi’s gone, is still unresolved.
As noted by MIT economist Simon Johnson, troubled Eurozone nations have a significant amount of foreign debt ownership, making contagion a very real possibility if all goes wrong. For instance, 44.4% of Italian debt is held by foreigners while Greek debt stands at 57.4%.
Lest we forget, Greece still has no solidified political plan with PM Papademos as a mere placeholder. Day by day, the probability of default and Eurozone expulsion increases. In addition to Greece, Spain’s prospects worsened as it reported no growth in the third quarter, exposing the country to greater risk if contagion is transmitted there from Italy.
Taking a look at market trends, the S&P 500 still hovers below its 200-day MA (Moving Average) by -0.73%, a level which has acted as a glass ceiling during recent rally attempts. Our Domestic Trend Tracking Index (TTI) remains above the line by +2.33% as of yesterday, however, our international TTI is stuck in a rut unable to get out of bear territory (-6.41%), which is why we’ve avoided international equity exposure.
For me, it’s hard to rationalize why markets did well this week. One thing is for sure though – Europe’s problems will continue and risk won’t diminish until some sort of long-term resolutions concerning Greece and Italy are put in place.
As this week has shown, any negative news from the European theater can pull the rug out from under the equity market with lightening speed. This is why I’ll take refuge in my bond ETF and cash position while adding equity ETFs only on a selective basis.
Have a great week.
READER Q & A FOR THE WEEK
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A note from reader Richard:
Q: Ulli: Recently, PRPFX stopped out. If memory serves, your back test of PRPFX presumed repurchases when prices crossed above Stop Prices plus 2%.
Not too long ago, PRPFX closed 2% above its Stop Price. Do you recommend repurchasing PRPFX at this time, based upon the above criteria, or should we wait for different criteria? Or is PRPFX no longer necessarily a recommended fund for the next Buy cycle?
A: Richard: Sure, that is one way to get back in, and an acceptable one with ETFs.
Since mutual funds have trading restriction, my preference is to delay the entry point and see PRPFX close back above its long-term trend line, which it did recently. Alternatively, if you prefer an earlier buy point, you could use the ETF equivalent of PRPFX as featured in model portfolios (#7).
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