Bigger Than A New Dow Record... U.S. Stock ETFs 'Decouple' From Foreign Stock ETFs

Includes: VGK, VTV, VWO
by: Gary Gordon

Prior to the 2007-2009 financial meltdown in the U.S., risk-takers thoroughly embraced the idea that emerging markets would regularly trounce the developed economies. At times, this simply meant that emerging market stocks would outperform on the upside. At other times, this referred to the ability of “emergers” to hold on to gains… even if U.S. stocks were faltering.

The investing idea that one region’s equity markets could move independently from another’s market had been dubbed “decoupling.” In fact, the term received so much attention, it has been used to describe unanticipated moves between other types of risk assets. For example, high yield bonds are supposed to behave more like stocks. At the start of 2013, however, rate sensitivity had caused the class to dip with investment grade bonds, and “decouple” from the rising stock market.

As the media celebrate record highs for the Dow Jones Industrials, you won’t find much about the decoupling that has occurred in 2013. Vanguard Value (NYSEARCA:VTV) has jumped roughly 7.5%. In complete contrast, Vanguard Europe (NYSEARCA:VGK) is flat, and Vanguard Emerging Markets (NYSEARCA:VWO) is down -4%.

Are the declines and near-term downtrends for non-U.S. ETFs hinting at an eventual pullback for U.S. stock ETFs? Should we expect diversified stock indices to eventually “RE-couple?” And if so, is it more likely that non-U.S. funds will catch up with the extraordinary rally in domestic equities?

In my estimation, U.S. stocks haven’t really taken a meaningful breather in 16 weeks. For that matter, we haven’t seen a full-fledged 10% correction since the “fall” of 2011. And perhaps most curious of all, non-cyclical stocks (e.g., consumer staples, pharma, utilities, etc.) are largely outperforming cyclical stocks (e.g., technology, energy, materials, etc.).

Sector ETF Leadership: Non-Cyclicals Are In Charge
1-month %
Consumer Staples Select SPDR (NYSEARCA:XLP) 4.0%
Utilities Select Sector SPDR (NYSEARCA:XLU) 3.7%
Health Care Select Sector SPDR (NYSEARCA:XLV) 2.6%
Consumer Discretion Select SPDR (NYSEARCA:XLY) 3.1%
Industrials Select Sector SPDR (NYSEARCA:XLI) 2.4%
Financials Select Sector SPDR (NYSEARCA:XLF) 2.2%
Technology Select Sector SPDR (NYSEARCA:XLK) 1.5%
Energy Select Sector SPDR (NYSEARCA:XLE) 0.2%
Materials Select Sector SPDR (NYSEARCA:XLB) -1.4%
S&P 500 SPDR Trust (NYSEARCA:SPY) 2.1%

Regardless of the cause(s) — a eurozone flare-up, ongoing dysfunction in D.C., employment uncertainty, slowing economic growth — even the best rallies do not go unchecked. I believe it is sensible to have a bit of cash on hand, even if stocks appear immune to a significant sell-off.

Put another way, investors today should think about doing the opposite of their greatest fear. And most investors are petrified of missing the next big leg up in the markets; few investors fear a pulverizing downside slide. If you’re scared that you’ll miss the next big move higher, bank a few profits and raise a modest amount of cash.

Disclosure: 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 web site. ETF Expert content is created independently of any advertising relationships.