I’ve been asked a lot about ETFs recently since I’ve called them out as one of the main reasons why the stock market experienced big selloffs leading into the new year. So, today, I want to talk more in-depth about how they work and the impact they can have on the market.
Essentially, ETFs, or exchange-traded funds, are indexes. An ETF is a bucket of stocks that can track the major indices, a particular sector or even gold and commodities. ETFs really took off in 2009, back when everyone was trying to track the upward movements of red-hot sectors. At that time, stocks were trading in packs, which made ETFs a good way to scoop up extra profits.
They also have spreads. The “bid” is what someone is willing to pay for the ETF, while the “ask” is what someone is willing to offer as a sale price. The difference between the bid and ask is the spread. And more recently, those spreads were growing wider and wider, which triggered panic selling in the fourth quarter.
In particular, we saw that happen in the selloffs leading up to Christmas Eve. Wall Street had checked out for the holidays, so volume was very light. The truth of the matter is that a lot of the ETFs traded at 4%-6% below net asset value, which caused them to swing all over the place. The good news is that the ETF spreads are tightening up and getting near normal. But they’re still not normal enough for me, and I recommend sticking to individual stocks.
So, the even better news is that the fourth-quarter earnings season has kicked off, and stocks will superior fundamentals should lead the market higher.
For this quarter, the S&P 500 is forecast to see a 16% increase in operating earnings and for sales to be up 6%. And so far, so good. According to Factset, of the 4% of companies in the S&P 500 that have released results so far, 90% have reported a positive earnings surprise and 65% have reported a positive revenue surprise. This is especially impressive considering that earnings are expected to decelerate given tougher year-over-year comparisons.
Personally, I expect energy, specialty retail, healthcare/medical device and cloud computer/cyber security companies to have the strongest fourth-quarter results and lead the market higher.
So rather than invest in ETFs, I recommend that you focus your time, energy and hard-earned cash on stocks. In fact, I shared my top nine energy stocks for this earnings season just last week to help get you in good position. In case you missed it, you can catch up here.
There’s an old adage, “As January Goes, So Goes the Year.” In other words, where the S&P 500 closes for January tends to signal how it will do for the rest of the year. Even with the selloffs in early January, the S&P 500 is still up 4.2% year-to-date. So I would say things are looking pretty good right now, and I only expect them to get better as fourth-quarter earnings are released. As long as you stay in stocks with superior fundamentals, you’ll be just fine.