Financial Markets Have Not Been Handing Out Participation Trophies

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I watch more football than I should. It may have something to do with the ability to see any game or any highlight on DirecTV in real time.

Or perhaps there are few parenting responsibilities with my 19-year old daughter attending college 60 miles south of our Orange County home. Or maybe it’s a semi-conscious desire to avoid working out at the nearby LA Fitness.

Regardless, I could barely keep my eyes open during Monday night’s contest between the Colts and the Panthers. Tedious? I thought it was a “Snooze Fest.” I found myself cheering more for a Kia car commercial than the yawn producing match-up on the field.

In case you missed the advertisement, the camera focuses in on a father who is beaming with pride. His son’s team has just finished an entire season without losing a single game. The dad asks his child to see the trophy and it reads, “Participant.” Disdainfully, he proceeds to remove the flimsy tag and write in the word, “Champs.”

Yes, I am one of those old school thinkers who believes that participation is its own reward and that it does not need to be acknowledged. You should get an “A” for performance, not for effort. You should get a raise for what you bring to a conference table beyond your backside. “Showing up” is not deserving of the same pay, the same grades or the same accolades as those who are achieving more.

My ideas of morality and social sensibility notwithstanding, there are times when things still get out of whack.

Imagine a classroom where two standouts receive “As” and thirty-two others receive “Fs.” Where are the Bs, Cs and Ds? Chances are, a teacher is failing his/her students.

Similarly, picture a company with three executives earning tens of millions and three thousand employees earning minimum wage. Where are the highly compensated folks, the relatively well-paid skilled producers and the modestly compensated workers?

In this scenario, the extent of the income inequality is likely to end in revolt.

In the financial markets, different asset types are always competing for our investing dollars. Moreover, when a particular asset class like U.S. stocks has only a handful of companies holding up a benchmark like the S&P 500, the probability for a revolt by the collective will of all corporate shares rises immensely.

This is precisely what transpired in the August-September sell-off. Market participation (a.k.a. “market breadth”) broke down well in advance of the sell-off.

Of course, the October rally has seen participation in a bullish uptrend improve dramatically. Nearly 72% of S&P 500 stocks now exhibit bullish uptrends. That’s not far from the 75% participation that existed in the first five months of 2015.

BPSPX

On the other hand, equal-weighted ETFs continue to warn that things are less than hunky-dory. Consider the performance of Guggenheim S&P 500 Equal Weight (RSP) at different periods in the current U.S. stock bull.

Year-to-date, RSP is underperforming the S&P 500 SPDR (SPY). This suggests that market-cap leading components (e.g., Facebook (FB), Apple (AAPL), Microsoft (MSFT), etc.) have been doing the heavy sledding and that, when one weights all of the companies in the S&P 500 evenly, the bull market is less healthy across the entire landscape than many would like to admit.

SPY and RSP YTD

Now gander at the outperformance of RSP over SPY in the three years prior. During the three-year run (2012-2014), strong gains across the participant components of the S&P 500 indicated a broader willingness to take risk than in the present environment.

RSP SPY 2012-2014

Ironically, the circumstances within the NASDAQ 100 are eerily similar.

Take a look at the performance of First Trust Equal Weight NASDAQ 100 (QQEW) versus PowerShares NASDAQ 100 (QQQ) at different periods. Year-to-date, QQEW is underperforming QQQ. Once again, this is evidence of less-than-ideal participation. During the three years prior, however, QQEW kept pace with QQQ.

QQQ QQEW YTD

QQEW QQQ 2012 2014

The relative underperformance of equal-weighted ETFs can be observed across numerous sectors as well.

Year-to-date since the summertime, the Guggenheim Equal Weight Technology (RYT) is struggling relative to the market-cap weighted The Technology SPDR (XLK). Less participation (a.k.a. less market breadth) is typically an undesirable omen. Once again, take note of the healthier participation in the previous three years.

RYT and XLK YTD

RYT XLK 2012 2014

None of these observations definitively prove that the current rally is doomed in the near-term.

On the contrary.

As discussed last in last week’s commentary on our current allocation for moderate growth and income clients, we embraced the successful retest of the August lows for SPY and QQQ in late September. We bumped the 50% equity component up to 60%, which is roughly 5% shy of a 65-35 standard.

That said, the internal weakness across components of popular benchmarks like the Russell 1000, S&P 500 and NASDAQ 100 should not be ignored. If that weakness intensifies, as it did in in May, June and July of 2015, we would likely raise cash levels as we did in the summertime. What’s more, investors should keep in mind that bond investors are still somewhat skeptical about the sustainability of the stock rally beyond calendar year 2015.

The spread between high yield (BBB) and comparable treasuries is still elevated and the spread is still greater than what it was in mid-September.

Credit Spreads

You can listen to the ETF Expert Radio Show “LIVE”, via podcast or on your iPod. You can follow me on Twitter @ETFexpert.

Disclosure Statement: ETF Expert is a web log (“blog”) that makes the world of ETFs easier to understand. Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc., and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert website. ETF Expert content is created independently of any advertising relationship.

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