The first thing I noticed when I arrived at the Inside ETFs conference in Hollywood, Florida, last week were the numerous “Happy Birthday SPY” signs. They were everywhere, and the birthday theme continued throughout the conference.
A 25th birthday party was held for SPY—the S&P 500 exchange-traded fund (ETF)—at the conference on January 22. Party favors in the form of little silver trays marking the event were distributed. Speeches were made, and congratulations were extended to State Street Global Advisors, the originators of SPY.
It was significant that SPY had reached the 25-year milestone. Its longevity was not only a sign of the continuing popularity of investing in the S&P 500 but also the staying power of the so-called new kid on the block—the ETF industry.
Talk about disruptive technologies. ETFs have become the fastest-growing investment vehicle, surpassing mutual funds in their rate of growth. With “just” $4.3 trillion in investment dollars, though, they still trail mutual funds’ $7 trillion in assets under management. But industry experts are predicting ETFs will actually surpass mutual funds before 2025.
SPY started it all on January 22, 1993. On that day, the fund began with seed money of $6.53 million; today about $280 billion is in the fund. One million shares traded that first day. Today, the three-month average daily trading volume is 65 million shares worth about $18 billion.
I think much of the success of SPY can be attributed to the Index it tracks, the Standard & Poor’s 500, which itself tracks the daily price changes of America’s 500 largest firms. Still, the success has been complementary.
When SPY first came out, the Dow Jones Industrial Average was the most-cited stock market index. But Dow Jones was slow to embrace the ETF movement, and by the time the Dow Diamonds made their appearance in 1998, SPY already had a commanding lead in the ETF market. It also began to be cited at least as much as the Dow when stock market performance was discussed. Today, I think the S&P 500 is the most cited and that SPY’s success had a lot to do with that.
One of my early contacts with ETFs came in 1998 when I made a due-diligence trip to the now-defunct American Stock Exchange for a presentation on ETFs and a trip down to the trading floor. Barclays had just opened its World Equity Benchmark Shares (WEBS), which later became iShares MSCI Index Fund Shares. WEBS tracked MSCI country indices (originally 17) of the funds’ index provider.
This made international investing available to the average investor. Bond, commodity, and now smart-beta and active ETFs, have joined the available menu of what amounts to thousands of ETF offerings
As I watched the traders on the AMEX floor handle the flow of funds with banks of computers, monitors, and many handheld devices, it was not that hard to imagine that I was witnessing the beginning of something big.
Because the new ETFs were just baskets of stocks, they could be easily hedged against, ensuring liquidity and ease of operation and investing. Because of the mechanism of creation, they also enjoyed tax advantages during their growth phase over traditional mutual fund investments.
Today, most all of Flexible Plan’s 150+ strategies could be traded with ETFs. Because of the cost of trading, though, the monthly (as contrasted with the daily) traded strategies seem to be the best fit for the ETF market, balancing low expense ratios against the trading costs that mount as activity increases. Most trading of these strategies occurs at Folio Institutional and Schwab, although it has started at Trust Company of America and TD Ameritrade.
Ironically, ETFs, and specifically SPY, arose as a response to the Security Exchange Commission’s (SEC) 1988 report, “The October 1987 Market Break.” Unfortunately, for me and investors generally, most investors had not been invested with FPI in 1987 when the market fell over 25% in a single day and all FPI Classic investors were in money-market funds instead.
In examining that crash, the SEC placed the blame on “program trading,” a portfolio insurance plan backed by Nobel Prize winners. In the report, the SEC suggested that the creation of a market maker to trade a basket of stocks would “alter the dynamics of program trading.” The planning soon began on what later became known as ETFs, and SPY was created.
I say “ironically” when referring to the SEC’s crash-avoidance motivation for SPY’s origination because I believe a lot of investors have been similarly motivated to buy SPY in the 25 years of its existence. After all, they are investing in America’s top 500 companies, right? Yet, SPY’s history over that period does not support that belief at all.
The S&P 500 and SPY have lost 50%, not once but twice just in this short century to date. As recently as 2011, the ETF lost about 20%. And have we really forgotten the way 2016 started with SPY losing 11%+ in just five weeks (from November 3, 2015, to February 11, 2016, the loss was actually 15%+)?
Such a record suggests that SPY is not for the faint of heart. It further suggests that most investors would be foolish to put all of their eggs in one SPY basket. The risk levels of SPY by itself are just too great for the average investor.
Yet as investors begin to receive their 2017 statements from mutual funds and brokerage firms alike, we all will see the ubiquitous benchmark comparison, inevitably to the Index underlying SPY: the S&P 500.
Why would we compare our portfolio’s performance to an index whose risk is not compatible with the risk profile of most of us? Most investors create diversified portfolios to lessen this risk. And active investors, like Flexible Plan clients, want to go beyond diversification to seek to avoid risks that even so-called diversified portfolios don’t protect against.
Why then compare these investment portfolios of assets or, better still, FPI’s dynamic, risk-managed strategies to an index of growth companies? The S&P 500 Index has required investors to earn a 100% return twice in the last 17 years just to return to breakeven. Why is it my clients’ benchmark? Why is it yours?
At Flexible Plan, we’ve created custom benchmarks for each client’s statement. The resulting OnTarget Investing Monitors allow clients to compare their portfolios’ performance quarterly to a personalized benchmark based on the actual strategies held in their portfolio in the proportion that they hold them.
Happy birthday, SPY! Your creation was a game-changing event, but I’m so happy you did not remain an only child. You’re great as a portion of a diversified portfolio, and you’re a fantastic tradeable security for market timing and dynamic risk management. But as a benchmark for all investment portfolios? I don’t even think your proud mother would have envisioned such a thing.
The party atmosphere continued on Wall Street last week, at least among stock market investors. The market hit another new all-time high last week. That’s 14 all-time highs this month—the most in a month for all but two years in the S&P 500 Index’s history.
Still, it was mostly a large-cap rally last week. It was not all that positive for mid-caps, and small caps actually lagged. International stocks of developed countries more closely followed the large caps, while emerging markets led the way among the equity indexes. Check out Evolution Emerging Markets in the Solution Selector. It’s one of our newest strategies and has already gained 11.72% year to date after applying our maximum fee rate.
Stocks have soared so much that nearly everything equity-oriented is strongly in overbought territory. Even the advance-decline index is there. Over 70% of issues in the S&P 500 are trading above their 50-day moving average, normally a topping level. And the Dow appears to be accelerating higher at a near-parabolic rate!
While seasonality is usually weak in February, that’s not the case when January starts as strong as it has this year. As we pointed out last week, since the 1940s, stocks have finished mostly higher after starts like this one.
Earnings season is about halfway over, and the results seem to support the index moves to record highs. So far, 70.1% of companies have beaten their average analyst estimate, the most since 2006. More importantly, revenues have bested the estimates 71.6% of the time. If that’s maintained, it will be the top performance on the revenue front since 2004.
Still, some investors are not convinced that stocks are the place to be. The American Association of Individual Investors index of bullish sentiment actually fell below 50% last week.
Perhaps they were scared off by the lower-than-expected GDP growth reported on last week or the weakness demonstrated by the housing report. While experts quickly pointed to the strong internal components of both reports, they will bear watching for a continuation of the not-expected trend.
Our strategy indicators continue to have us fully invested in stocks, and leverage is still being employed. The economic reports last week have not changed the current posture of the All-Terrain indicator (see our Current Market Regimes on the left side of this page). It continues to rate the economy “Normal” and favorable for stocks. Our Volatility regimes (based on a mixed stock, bond, and gold volatility measure) is rated “High and Falling,” which favors aggressive stock investments, but also high yields and contrarian strategies.
With the equity market so overbought, some concern must exist that sooner or later this amazing stock market ride must end. After all, it has been over a year and a half since we have experienced even a 5% correction. It’s been over a year since a 3% move lower. That is likely to change.
Combine that lack of volatility for such a long period with the heights the Dow has achieved. It’s now over 26,000. That means the next time the Dow falls 2%, the Index will be down over 500 points, about the same amount as it slid in the 1987 crash! Will most investors understand that the higher the Dow goes the worse the Dow will look on a points-lost basis?
While it is all relative, the effect of this combination may make the next decline something that we have not seen in quite a while. I believe it helps to have some active management strategies in the portfolio to provide comfort if times get scary for some investors.
While the party has gone on now for some time for equity investors, bond investors have underperformed for quite a while now.
The 30-year party for bond investors seems to be over.
Happy 25th birthday, SPY!
All the best,
P.S. Flexible Plan Investments celebrates its own birthday on February 1! 37 years… seems like only yesterday.
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