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(Arpad Benedek/Arpad Benedek / iStockphoto)
(Arpad Benedek/Arpad Benedek / iStockphoto)

ETFs

It's time to sell market-sensitive ETFs Add to ...

Second-quarter report season will provide an interesting opportunity to reduce exposure in Canadian and U.S. equities and their related exchange-traded funds. Between June 24 and July 8, the TSX composite index has gained 3.2 per cent, the Dow Jones industrial average has improved 4.0 per cent and the S&P 500 index has increased 4.6 per cent.

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History is repeating. During the past 62 years, the S&P 500 index has recorded a gain 71-per-cent of the time from the last week in June until the fifth trading day after the U.S. Independence Day holiday partially in anticipation of good news from second quarter earnings reports.

This year, additional gains by North American equity markets early this week are likely following release of a bullish U.S. June employment report on Friday. However, gains are not sustainable.

Consider the following:

Second-quarter earnings to be reported by major U.S. and Canadian companies are unlikely to generate an enthusiastic response by investors. Consensus estimates for earnings on a year-over-year basis by S&P 500 companies show a gain of only 3.0 per cent. However, estimates have come down from 7.0 per cent at the beginning of April and may be too high. More recently, 87 out 111 S&P 500 companies have lowered second-quarter guidance. Yes, many S&P 500 companies will beat their guidance by a penny as usual. However, the trend to lowering earnings expectations is well in place. Earnings by the 30 Dow Jones industrial average companies also are expected to increase by an average of 3.0 per cent on a year-over year basis. Earnings by the TSX 60 companies are expected to increase by an average of 5.4 per cent. Sectors expected to report the strongest year-over-year gains are energy in both countries and financial services and home builders in the U.S. Weakest sectors are expected to be technology, base and precious metals and steels. 

Of greater concern is the reporting of second-quarter revenues. Consensus for revenue growth by S&P 500 companies is a gain of only 0.3 per cent on a year-over-year basis. Watch for major international companies to explain a lack of growth in revenues due to strength in the U.S. Dollar Index. Average value of the U.S. Dollar Index increased in the second quarter this year to approximately 83.0 from approximately 80.5 last year. Upon translation into U.S. dollars, revenues from international operations must increase 3.1 per cent to break even with revenues last year.

Of greatest concern is third-quarter guidance that major international corporations will offer when they release second quarter earnings and revenues. On Friday, the U.S. Dollar Index broke to a three year high to close at 84.71. Last year in the third quarter the U.S. Dollar Index averaged approximately 81.0. In other words, revenues and earnings from international operations translated to U.S. dollars will need to increase by 4.6 per cent in order for revenues and earnings to break even in the third quarter. Meanwhile, economic growth in markets outside of the U.S. including Canada, Europe, most emerging nations and China has been less than robust.

Seasonality also offers caution for equity markets at this time of year. North American equity markets have a history of reaching an intermediate peak either in the first week in May or in mid-July. After July comes August, the fourth-weakest-performing month for the S&P 500 index, the third-weakest-performing month for the Dow Jones industrial average and the TSX composite index and the second-weakest-performing month for the NASDAQ Composite Index during the past 62 years. After August comes September, the weakest-performing month of the year for the S&P 500 index, the Dow Jones industrial average, the TSX composite index and the NASDAQ composite index during the past 62 years.

Preferred strategy is to take advantage of recent equity market strength to reduce equity exposure in market-sensitive exchange-traded funds between now and next week. Proof in the strategy will come from responses to second-quarter reports that start to appear this week.

Don Vialoux is the author of free daily reports on equity markets, sectors, commodities and exchange-traded funds. Daily reports are available at http://www.timingthemarket.ca/. He is also a research analyst for Horizons Investment Management Inc. All of the views expressed herein are his personal views although they may be reflected in positions or transactions in the various client portfolios managed by Horizons Investment Management.

Follow on Twitter: @EquityClock

 

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