January 29, 2019

Despite a positive undercurrent, volatility returned last week. I have been carefully monitoring ETF spreads to see if the stock market is finally becoming “normalized.” I am happy to report that the abnormally-wide ETF spreads in the fourth quarter – which complicated and deepened the correction – tightened up, which is important for investor confidence. Unfortunately, ETF spreads remain elevated.

For example, last Wednesday, an hour after the market opening, DVY was trading at a 19-cent spread (0.2%), while SPY was trading at a $1.08 spread (0.4%), according to Morningstar’s Intraday Indicative Value. DVY and SPY are two of the biggest and most liquid ETFs traded. ETF spreads tend to tighten up at the market’s close, so if you are trading ETFs, I strongly recommend that you buy or sell ETFs near Morningstar’s Intraday Indicative Value via a limit order, or near the market close, when spreads tighten.

To give you an idea of the wide spreads that dominated the ETF market in 2018, according to research by our friends at Bespoke Investment Group, SPY rose 13.1% in 2018 “after hours,” when the stock market was closed, but it declined 17.2% during regular trading hours in 2018. Clearly, this 30.3% performance differential in the most liquid, largest, and oldest ETF is disturbing, as it undermines investor confidence.

I should add that Wall Street’s new invention of “no transaction fee ETF trading” does not eliminate the ETF spread, just the brokerage commission. Essentially, this is how selected ETF firms pay brokerage firms for order flows, but there are all-too-often extra charges if an investor sells ETFs a bit too quickly.

The ETF spread dilemma is thoroughly discussed in Jason Bodner’s new report, ETF-DOOM Sharks. This white paper also discusses how the growth in both algorithmic trading and ETFs has made the stock market much more volatile, which essentially triggered the recent stock market correction. Jason is a former institutional ETF trader and has unique insights into ETF trading that serious investors must read.

Interestingly, Jim Cramer is calling for the SEC to investigate the “Christmas Eve crash” that was caused largely by panic ETF selling pressure. Ironically, Christmas Eve marked the recent low for all major market averages – and the first day of the government shutdown. The SEC was one of the first agencies shut down – since it ran out of funding on December 26th, the day the market started recovering.

Major Governments Bypass Davos for Political Reason

The World Economic Forum in Davos, Switzerland last week was not anywhere as big as it had been in previous years. President Trump and all official U.S. government delegates canceled their trip due to the U.S. federal government shutdown, while French President Emmanuel Macron and British Prime Minister Theresa May also bypassed Davos due to domestic unrest and the Brexit mess.

Nonetheless, Ray Dalio, founder of Bridgewater Associates, the world’s largest hedge fund, got attention in Davos when he said, “What scares me the most longer-term is that we have limitations to monetary policy … which is our most valuable tool [and] we have greater political and social antagonism.”  Dalio said that the Fed’s limited monetary policy toolbox, rising populist pressures, and other issues, including rising global trade tensions, are similar to the backdrop leading to the Great Depression in the late 1920s. Obviously, by implying that the current environment is increasingly like the years that preceded the Great Depression, Dalio got a lot of media attention, but his comments did not impact the financial markets.

If there is an impending global event that we need to pay attention to, it is the implementation of Brexit on March 29th. Britain apparently has no intention of paying the billions of pounds or euros in exit fees that the European Union (EU) is demanding. Furthermore, the euro and the British pound are not acting well on fears of what might happen. If anything, the U.S. is expected to continue to be an oasis for international foreign capital that may be fleeing both the euro and the British pound. As a result, Treasury yields may decline sharply as we approach March 29th if Brexit does not go smoothly.

Venezuela is in the midst of a crisis as some military members increasingly reject President Nicolas Maduro. On Wednesday, the U.S. followed Brazil and other Latin America countries by recognizing Juan Guaido as Interim President of Venezuela. Guaido is the head of the Venezuelan National Assembly and is increasingly backed by Venezuela’s citizens and military leaders. In the meantime, President Maduro terminated diplomatic relations with the U.S. and gave U.S. diplomatic personnel 72 hours’ notice to leave. It is uncertain how any Venezuelan oil refined in the U.S. will be impacted by this chaos.

Despite the deal on Friday to temporarily reopen the federal government for three weeks, the State of the Union will likely be delayed until after the Super Bowl. In the meantime, the relationship between President Trump and Speaker Pelosi appears to be worse than ever, because Ms. Pelosi informed President Trump earlier last week that he was not welcome to speak in the House Chambers while there was a federal government shutdown. Specifically, Speaker Pelosi said that President Trump would be welcome to speak on “a mutually agreeable date for this address when the government has been opened.”

Interestingly, the stock market rose well over 10% during the federal government shutdown, so I would not worry overly about the market’s reaction to another possible shutdown in upcoming months.

First-quarter GDP is now expected to be flat due to the federal government shutdown and severe winter weather in the Midwest and Northeast. Furthermore, the economic news released last week was not very promising. On Thursday, the Conference Board announced that its Leading Economic Index (LEI) declined 0.1% in December, which is not surprising, since the stock market, Treasury interest rate spreads, and building permits are some key LEI indicators. Ataman Ozyildirim, Director of Economic Research at The Conference Board, said, “While the effects of the government shutdown are not yet reflected here, the LEI suggests that the economy could decelerate towards 2% growth by the end of 2019.”

On Tuesday, the National Association of Realtors announced that existing home sales plunged 6.4% in December to an annual pace of 4.99 million, the slowest annual pace in over three years (since November 2015). In 2018, existing home sales declined 3.1% to 5.34 million as higher interest rates and rising home prices curtailed sales. Median home prices rose 2.9% in 2018 to $253,600 and are expected to continue to moderate in the upcoming months due to fewer buyers. Overall, due to the federal government shutdown and severe winter weather, existing home sales are expected to remain weak for the next two months.

About The Author

Louis Navellier

Louis Navellier is Founder, Chairman of the Board, Chief Investment Officer and Chief Compliance Officer of Navellier & Associates, Inc., located in Reno, Nevada. With decades of experience translating what had been purely academic techniques into real market applications, he believes that disciplined, quantitative analysis can select stocks that will significantly outperform the overall market. *All content in this “A Look Ahead” section of Market Mail represents the opinion of Louis Navellier of Navellier & Associates, Inc.*


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