XYLG - S&P 500: Buy Summer Sell Autumn Scenario Favors IVV XYLG

2023-06-05 09:21:27 ET

Summary

• I see a potential broadening of the stock market rally, driven by the S&P 500 Index, making a bullish case for the summer.
• The performance of FANG stocks and the Invesco S&P 500 Top 50 ETF indicate a top-heavy market, but I see potential for broadening in early June.
• I recommend a "hybrid" approach to S&P 500 exposure, considering Global X S&P 500 Covered Call & Growth ETF as a timely option for the hesitant investor.

Everybody in the pool! That seems to be the prevailing attitude on Wall Street as we enter the summer season. What has been a mega cap stock flurry since the start of this year is finally starting to look like there may be a chance of broadening out. And, as bearish as I am about the long-term fundamental hurdles facing the global economy and financial markets, an interim bullish case gets stronger by the week. Let’s take a deeper look to see why. Hint: it has less to do with what TV headlines are telling us, and more to do with a simple dissection of the S&P 500 Index, which I’ll portray through iShares Core S&P 500 ETF ( IVV ).

Interestingly to me, as an investor who always aims to be bullish on protecting his backside, and bearish on arrogant investing, this sets up as a nice opportunity for what I’d refer to as a “hybrid covered call ETF” in Global X S&P 500 Covered Call & Growth ETF ( XYLG ). More on that after I explain my “bullish summer/bearish autumn” take.

How we got here: "FANG" you very much!

See below for performance of a group of four ETFs since the end of October last year, around the market lows. That is, the lows for FANG stocks, the Nasdaq 100 (not shown) and the S&P 500 index. IVV has advanced nearly 12% in the past 7-plus months since that October low point.

However, that doesn’t tell the story much at all. The blue line below does. That’s FNGS, which is a 10-stock ETF that owns all the “usual suspects” when it comes to what has dominated market performance, driven the headline indexes, and created excitement in equity investing reminiscent of the meme stock craze we saw not long ago. A 67% gain since last October-end tells me one of two things:

1. The market just started a wild, bubble-ending run that could end in weeks, not many months from now, supporting the “summer rally” thesis. However, it could fall flat on its face once the autumn comes, and the reality of 5% worth of rate hikes finally trickles its way into the economic behavior of consumers. To me, that is the big wildcard in all of this. Apparently, no one told folks that eventually, they will have to pay back those credit card bills, auto loans, vacations they really couldn’t afford but had to take anyway, and student loan dollars that were spent on things other than education. My personal belief is that this will all come down hard in an enduring recession. But I’ve continued to be amazed at how long this debt bubble continues, largely unchecked. Sort of like how Congress can keep raising the debt ceiling (which really is about paying for what was already spent) while only making modest cuts to future spending.

2. Since the stock market can go long periods without caring at all about the items I listed above, the other scenario (the sustained bull case) is that these assumed market leaders did their job as leaders, broke down the door, and now the rest of the crew (stocks in the S&P 500) can come on through and have their upside moves, too. Summer should tell us a lot more about this. And frankly, I continue to be of the opinion that this bull run can be interrupted at any time. But just because the stock market is not to be trusted (my opinion), it doesn’t mean I can’t partake while the good times are rolling.

Data by YCharts

Another strong indicator of the top-heaviness of today’s market is in how well Invesco S&P 500 Top 50 ETF ( XLG ) has done over this time. I’ve used this one over the years as a way to take a bullish stance on a narrow US stock market, since it cuts out the bottom 450 of the S&P 500 by size. My latest entry was back in mid-March. It still looks solid, but the broadening out I see potentially initializing here in early June makes me think I need to get a companion or two for XLG.

The last item in that chart is the equal-weighted S&P 500. It has not had the thrilling upward move the others have, despite the fact that it is made up of all the same stocks as IVV. But when we equal-weight that same S&P 500, we find that the average stock has only gained 4% since October-end. That’s not bad, but you can see the FOMO brewing on the part of any investor who had to “settle” for 4% versus 12%, 19% or 67%. This is 2023’s stock market in a nutshell.

Where we are now: breakout.. . or fakeout?

I’m not going to bore you with technical analysis stuff, but I will present one quick picture that took me from highly-suspicious of the narrow, FANG-driven rally to, shall we say, a bit less suspicious, for now. Below, see IVV’s 20-day and 50-day moving averages. They have both been on the rise since early April, but I dismissed that because it seemed very obvious to me that all of the “lift” in IVV was driven by a small number of stocks, as I showed above.

Data by YCharts

So, what’s different? I’ll spare you my fancy charts this time around, so as not to induce sleep, and simply say that there is a growing persistence to these moving average moves, one that has taken them marginally past the highs of last August, just before the stock market had a sharp decline, which led to the October low. Furthermore, the next peg on the ladder back toward the January 2022 all-time high and a potential new bull market is getting closer. The bottom-line is that IVV is now starting to pass the “breadth” or broadening out tests that started with FNGS, continued with XLG and is now starting to involve more stocks.

What could go wrong? Plenty.

As a technician since my late father taught me with a pencil and graph paper in 1980 (I was a teenager then), there’s one thing I can say with confidence about technical analysis and newbie technicians today: they don’t make them like they used to. The markets work very differently today, driven by a host of new participants that my Dad could never have imagined. Algorithmic trading, options that expire in one day, ubiquitous financial media, etc. The result for we tenured chartists: we don’t trust the formerly reliable indicators quite as much as before. Specifically, breakouts like the one brewing in the S&P 500 will be great for a moment, but will it last? We’ll know soon.

XYLG: timely consideration for the hesitant

XYLG is a small ETF that I suspect many investors will ignore, but shouldn’t. As with any ETF, especially “undiscovered” types like this one, it has a role to play at certain parts of the market cycle. And, if my assessment of the near-term upside, followed by a reckoning later this year for the S&P 500 does play out, XYLG can provide a “happy medium” approach to navigating that part of the cycle, and probably be a long-term holding (i.e. holding it for more than 12-months).

That’s because XYLG sells covered calls on the S&P 500, just out of the money, so it retains a bit of upside. However, that’s only half of the portfolio. The rest is an unhedged S&P 500 index. As the chart above shows, this approach has produced a return in line with IVV since late 2021 (once XYLG was up and running long enough to post a 12-month dividend yield), and a yield currently more than 4% over IVV. I think of it this way: at different points in the market cycle, there are different ways to have my S&P 500 exposure. Currently, this is an opportune time to have a "hybrid" approach to that S&P 500 exposure.

So, for investors who like the covered-call concept, and the index concept, but prefer a blend of both at precarious parts of the market cycle like this one, this is a consideration. It is not the strongest “table pounding buy” I’ll ever issue. But I like Global X’s transparent approach and pure simplicity in this area, versus JEPI’s similar partially-hedged feature.

XYLG’s expense ratio is 0.60% and that’s on the high side. But as I’ve noted many times, expense ratio is an over-rated aspect of investing. Would I have paid a premium to get what FNGS just did? You betcha!

Action items

Here’s how I am playing this view with the long side of my always long-and-hedged portfolio:

1. Continuing to hold XLG

2. Taking a close look at XYLG, and putting a Buy on it here

3. IVV is a “hold” but with an upward bias

4. Watching everything carefully, since this has the potential to be a sharp, fruitful but temporary rally, if it happens at all. Be careful out there.

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