Many investors—you may be one of them–maintain a constant position in the SPDR S&P 500 ETF (SPY). Because the S&P 500 Index, which the SPY represents, is the benchmark for the U.S. stock market, and because most fund managers are unable to beat the SPY’s performance, it makes sense to retain it as a core position.
Still, recent market volatility (wide price swings) and tumbling stock prices have sent some of us wanting to reach for the Maalox bottle.
If you’d like to stay in the market, and in the S&P 500, but with a calmer approach and minus the steep downside, you may want to explore a low-volatility fund that accomplishes that.
Before we discuss that fund, though, let’s get a clear picture of how the SPY, itself (and many other ETFs), is constructed.
The SPY is a “cap-weighted” fund. Cap-weighted funds award the biggest companies (by market capitalization) the highest portions of the underlying index; mid and small-cap companies in the index receive smaller shares according to their capitalization size. (Market capitalization = number of stock shares outstanding x share price.) So, the construction of the underlying index has a significant impact on the fund’s performance.
The bigger a stock’s weighting, the greater the influence it has on the ETF’s performance.
Currently, the top-six ranked components in the SPY by market-cap are Apple Inc. (AAPL), Microsoft Corp. (MSFT), Exxon Mobil Corp. (XOM), Johnson & Johnson (JNJ), General Electric Co. (GE), and Facebook Inc. (FB). Combined, these components account for nearly 13% of the fund’s weight.
For clues as to which way your fund may be headed next, keep an eye on the top three components in your cap-weighted ETFs.
Now, in bull markets–such as we experienced from 2009 to the final quarter in 2015– the SPY acts well. With the biggest, brawniest stocks in the U.S. stock market in the lead, the fund usually moves nicely higher. That’s the good news.
Here’s the challenging news: when the markets reverse to the downside, the overvaluation of large-cap stocks in the SPY (this dynamic also occurs in other market-cap weighted ETFs) can cause it to slide south, sometimes dramatically.
Indeed, on the weekly chart of the SPY, below, we can see the recent influence of the top components: Since the first of the year, the strong performance of Microsoft, Johnson & Johnson, Facebook and GE fought to keep the index ETF aloft.
But the frail performance of market cap giants Apple and Exxon pressured the SPY further to the downside. Where’s my Maalox?
Chart Courtesy RealTick®
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For those who want to maintain a position in the S&P 500 via an index ETF, but would like the position buffered during volatile, negative market moves, you may want to check out the
PowerShares S&P 500 Low Volatility Portfolio (SPLV). This ETF consists of the 100 stocks from the S&P 500 Index with the lowest realized volatility over the past 12 months. For example, the top three components are Airgas Inc. (ARG), Coca-Cola Co. (KO) and Verizon Comm. Inc. (VZ).
We know that from its May 2015 all-time high of 213.78 to this Friday’s close (Feb. 5) at 187.95, the SPY has tumbled 12% from its highs, putting it in “correction” mode.
In contrast, the SPLV is down from its December 2015 high at 39.24, to last Friday’s close at 37.21 by only 0.05%. No Maalox needed.
Chart Courtesy RealTick®
During volatile times like these, when you want to stay in the market and avoid ulcers at the same time, a low volatility ETF may be a consideration worth thinking about.
Until next time, keep green on your screen,
Toni Turner is the President of TrendStar Group, LLC, is an accomplished technical analyst as well as a popular educator and sought-after speaker in the financial arena.
She is also the author of best-selling books: A Beginner’s Guide to Short-Term Trading, Short-Term Trading in the New Stock Market and Invest to Win: Earn and Keep Profits Bull and Bear Markets With the GainsMaster Approach, co-authored with Gordon Scott, CMT.