Monday, January 20, 2014

Forecast of Top Index Funds for Equities – 2014 and Beyond

ETF Review and Outlook

A review of the top index funds sets the stage for a cogent approach to forecasting and investing in the stock market. For this purpose, the prime vehicles lie in the exchange traded funds for the leading benchmarks: the Dow Jones Industrial Average, the S&P 500 index, and the Nasdaq 100 yardstick. The tracking vehicles for these beacons are found in DIA, SPY and QQQ respectively.

By contrast to popular perception, the real and financial markets are intertwined not only in the future but also the present which in turn springs from the past. Given this backdrop, the adept investor examines the landmarks in the backward direction as well as the conditions in the current environment.

Moreover the outlook over the months to come depends not only on the currents in motion right now but also the contours of the landscape downstream. For this reason the survey at hand draws partly on, and fleshes out, the prospects for this year and beyond.

From a practical stance, the companies listed in the stock market earn their living within the economy at large. That much is true even in the case of virtual firms such as online retailers and brokerage houses. For this reason, the aggregate level of economic output plays a vital role in corporate earnings and thus the price action on the bourse.

In the real economy, the conditions have not changed a great deal over the past few years. On the downside, the politicians of the West have gone out of their way to solidify the distortions in the housing sector in the aftermath of the financial crisis of 2008.

Another boondoggle lay in the prop-up of some of the biggest and most unproductive firms in the economy. In this light, trillions of dollars were wasted in the form of bailouts for a gaggle of gutted banks.

To make matters worse, the struts put in place have prevented the property market from shedding the mountain of blubber it had piled up during the manic bubble in real estate in the run-up to the financial flap. For this reason, the growth rate for the entire economy is destined to be measly well into the 2020s.

In particular, the prospects for the industrial nations are lackluster at best. For this reason, the emerging markets of the world will have to plod along in spite of the general weakness in the wealthy regions.

On a positive note, though, the slowdown in the budding markets has run its course for now. A case in point is China, which will contribute more to the growth of the world economy in 2014 than it did over the past couple of years.

In short, the outlook for the real economy has improved somewhat since the same time last year. On one hand, we can expect the rich nations of the world to putter along and make way by about 2.0 percent after adjusting for the squeeze of inflation based on the official figures bandied about by government agencies.

Meanwhile the emerging regions as a group will contribute the lion’s share of the upturn in global output thanks to an upsurge of 5.6%. As a result, the world economy is slated to expand by some 3.0% over the course of 2014.

Thanks to the patchy but improving conditions in the tangible economy, the stock market is poised to climb higher as well. The cheery outlook shows up in the upward slant of the top index funds over the course of the year.

As an example, the first milestone for DIA – also known as the Diamonds – lies at a price of $140.71. This landmark is likely to be reached by the middle of the year. The milepost in sight lies a modest $13.83 beyond the initial figure of $164.39 chalked up by DIA at the beginning of January. In other words, the Diamonds are slated to rise but not get very far during the first half of the year.

Sadly, the outlook is not much better for the second half. For one thing, the market will likely struggle as usual over the course of the summer. For a second thing, the bourse will enter its weakest stretch of the year as September rolls around.

To add to the damper, the central bank in the U.S. will likely wrap up the latest round of quantitative easing around that time. As the spree of money creation winds down, the torrent of fresh cash flooding into the marketplace will no longer be monstrous but merely massive.

As a result, the bourse is apt to suffer a breakdown of middling size. The slump will likely amount to a halfway trip to the threshold of 15% that marks the low end of a full-blown crash in the U.S. In that case, the setback will result in a knockdown in the ballpark of 7 or 8 percent.

Given the specters on the horizon, the summer and autumn will be a good time for the cautious investor to stay clear of the stock market. On the other hand, the bourse should regain its footing and tramp upward once more during the last quarter of the year.

On a negative note, though, the U.S. bourse is unlikely to rise much beyond its prior peak set earlier in the year. In other words, DIA will struggle to regain its initial milestone in the $178 zone. By way of comparison, the Diamonds closed out 2013 at a price of $165.47. In that case, a high of $178 amounts to a modest increase of 7.6%. Not a great result.

From a different angle, suppose that the trend line over the past couple of years manages to hold up. In that case, the ramp-up over the year is a hike of 21.6% which in turn implies a milepost at $190.91. This second and last marker for 2014 represents a gain of some 15.4% over the price of $165.47 recorded at the end of last year.

The actual figure at the close of this year will of course depend on a slew of factors. A case in point is the amount of money conjured out of thin air by the central bank.

Another sample involves an uptick in the appetite for risk amongst the investing public. Given the huge run-up of the U.S. bourse last year, a horde of investors will pile into the arena. At the same time, the players at the head of the pack will begin to turn their gaze toward far-flung shores in search of greener pastures.

In that case, the lagging markets round the world should turn in a much better performance than they did last year. Examples in this vein run the gamut from from Britain to Korea.

In the financial forum, the leading benchmarks of the bourse tend to move in unison, as in the case of a peak or a trough that crops up at the same time. On the other hand, the magnitude of the moves tends to differ somewhat. More precisely, SPY is prone to head in the same direction as DIA but advance a tad more in relative terms.

The story is similar for QQQ, a tracking fund which also goes by the nickname of Qubes. The main difference lies in the tendency of the latter to display even larger swings in price than its major rivals.

For these reasons, a forecast for SPY – alias the Spyders or Spiders – is largely redundant when a projection is already available for the Diamonds. And likewise for the Qubes.

As the year wears on, the second and last landmark for DIA lies around 15.4% beyond its closing value of $165.47 in 2013. Based on the recent patterns in the marketplace, we can multiply the latter percentage by a stretch factor of 1.107 for the Spyders. The result is an upturn of some 17.0%. That is, the final milestone for SPY in 2014 should lie around 17 percent higher than its closing value at the end of last year.

We can obtain a similar estimate for the Qubes. The product of 15.4% for DIA and a scaling factor of 1.286 for the index fund comes out to 19.8%. As a backdrop, QQQ closed out the year at a price of $87.96. Based on the latter two figures, the last milestone for the tracking fund stands at $105.38.

In comparison to the stunted advance of DIA and SPY, we can also foresee a brighter future for QQQ for a different reason. On one hand, the Spyders and Diamonds have already passed their all-time peaks and are now plowing into unknown terrain. By contrast, the Qubes have ample room to advance before they regain their historic peak notched at the height of the Internet craze.

At the end of 2013, the Nasdaq fund wrapped up the year at a price of $87.96. The latter figure is a far cry from the zenith of $232.88 touched in March 2000. As a counterpoint, though, the latter price has to be halved due to a 2-for-1 stock split in the second half of March 2000. In that case, the corresponding price today turns out to be $116.44.

The latter figure lies within a stone’s throw of the last milestone of $105.38 projected for 2014. In view of the historical record, the mass of investors will do their darnedest to shove the Qubes up to their all-time high. And if the central bank prints up enough money out of the ether in the interim, the madding crowd may well succeed.

As a rule, we can expect the bourses in the budding regions to advance by roughly twice as much as the Diamonds or Spyders. For instance, a gain of 15% for DIA should result in an uplift of 30% or so for the emerging markets.

To sum up, the trio of index funds for the U.S. bourse will tramp onward and upward through a series of zigzags as usual. The story will unfold in a similar fashion for the other stock markets round the globe.

Although there are plenty of exceptions, the bourses in the budding regions often advance roughly twice as much as the Diamonds or Spyders. In that case, an upturn in DIA should result in a healthy gain for the emerging markets.

On a negative note, the feisty markets also tend to be the most volatile. Meanwhile the mass of investors remain somewhat skittish. As a result, the international crowd may hold back on moving in earnest into the sprouting markets until the last quarter of the year.

NOTE: The full report is a document in PDF form under the title of “Forecast of Top Index Funds for Investing in the Stock Market”. The updated version may be viewed or downloaded here.

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