Jason Browne, Chief Investment Strategist at FundX Investment Group
Topline market commentary: Regarding the current market, the big difference between this year and last year is we are seeing more volatility, we have higher short-term rates and there is a greater disparity between leading and lagging stocks. Since the February correction, leaders like small caps and tech have rallied to new highs but the S&P500 is still below the Jan highs and the DJIA is negative YTD.
Very short-term we have been overbought in most stocks and spent most of this week in a pullback. I wouldn’t be surprised to see another bout of volatility over the next months and we could see some of the leaders get hit if that happens – but so far, these selloffs have been pretty modest setbacks in an otherwise strong market. The picks we’re discussing today are some of the leaders that we own at FundX that are trending well and remain on my buy list despite the potential for near-term volatility.
The general theme that ties the ETF picks together is that leaders in the current market are tech and small caps.
At FundX, we have observed that market leadership changes in trends over time – in other words, there are extended periods when value strategies do well and others when growth is in favor. Similar patterns exist between foreign and domestic regions and even large and small cap stocks. Because these trends tend to last years and the difference in performance between leading and lagging areas is substantial, we built our strategy to identify the areas of the market that are currently leading and to capitalize on that by investing in the ETFs and mutual funds that are doing best for a given level of risk. The leaders in the current market are tech and small caps.
- FDN (First Trust Dow Jones Internet Index Fund) is our top pick for the aggressive part of a portfolio. It is a pure play on tech with 30% in the FANG stocks that have led for over a year.
o FDN is up about 30% this year and 50% for the trailing year – so it has had a great run – and it is volatile.
o We own it and continue to buy it in our aggressive strategy and to a lesser extent in our tactical strategy.
- IWO (iShares Russell 2000 Growth ETF) is another relatively aggressive pick because small caps are generally more volatile than large cap stocks.
o Small cap leadership has been less consistent than tech leadership but has gained traction as trade tensions have increased. IWO offers a low cost way to add exposure to small cap growth to a portfolio.
o IWO is up more than 10% this year – so it hasn’t been as hot as FDN – but it is much more diversified and is among a series of small cap growth funds that have recently come up our rankings.
o This is a buy for aggressive portfolios and to a lesser extent in our tactical strategy.
- MTUM (iShares Edge MSCI USA Momentum Factor ETF) is different – we consider it a core fund, for the part of a portfolio where you might own an S&P500 index fund, for example.
o This fund has done a great job transitioning its portfolio over the last few years and is currently aligned with our tech theme.
o It does have limitations in that it only invests in large and mid-cap US companies, so if the recent small cap leadership trend persists, this fund will be limited to buying more mid-caps. It does, however, have the flexibility to adapt as trends change – which is refreshing since most funds don’t do that.
o We have held MTUM in our growth, balanced and tactical strategies for more than a year and continue to buy it.
o MTUM is up closer to 9% so far this year and about 25% for the trailing year.
I don’t have a forecast for the next 3, 6 or 12 months – that’s not what we do at FundX. I also don’t buy a fund seeking a specific target return. At FundX, we allocate to stocks, bonds and cash based on investor goals and resources, then allocate to riskier or less risky funds within those areas based on investor preferences (and in our tactical strategy, based on our overall assessment of current market risk). From there, we identify and buy the funds doing best at a given risk level and re-rank the funds monthly. As funds and ETFs we hold fall in our ranks, we sell them and move to new leaders.
We call this process “upgrading.” We have done this as a firm for nearly fifty years and it’s worked well. Given that approach, it is important that we avoid getting anchored in forecasts. What I can say is that this year we are seeing much better performance from funds and ETFS that are focused on growth stocks than those focused on dividends and/or invested overseas.
No trend lasts forever, but most of the arguments against the current leaders could have been made months ago – and investors have been well served by staying the course.