Malcolm Graham
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After the market meltdown, this is the only asset that looks to be a survivor

ETFs tell the tale of a terrible third quarter

Chalk one up for the “Sell-in-May” crowd. By going away, they dodged the third quarter’s market trauma that is unsettling the investors who stuck around.

Now both camps are puzzling how to position themselves for whatever lies ahead. One method is to analyze where the markets have been and then project those conditions into the future. It isn’t perfect, and considerable horse sense must be applied in the process, but the exercise can help investors who are yearning for rationality.

To that end, we have assembled data on the market performance of index-based exchange-traded funds in the third quarter (through Sept. 25) and first half of this year. ETFs aren’t as “pure” as indexes — they can trade at premiums to or discounts from their underlying index values — but they are closer to what investors actually experience.

For example, here is how the major asset classes fared. Median performance (the midpoint of those ETFs chosen to represent each category) is a more stable statistic than simple average performance, which can be skewed by one or two outsize results.

Median Market Return
3rd Qtr.1st Half
U.S. Stocks-6.85%1.80%
Foreign Stocks-11.92%5.33%
U.S. Bonds0.26%0.59%
Foreign Bonds0.15%-3.37%
Real Estate-0.36%-5.60%
Commodities-15.76%-2.32%
Common sense is essential to interpreting this data and using it to posit future positions. For instance, foreign stocks did fine in the first half, and terrible in the third quarter; wouldn’t they revert to average performance and thus rebound? Probably not, because weakening global economic growth is a trend likely to continue.Speaking of trends, foreign bonds moved from a first-half loss to a third-quarter gain. Wouldn’t that be good to ride? Probably not, because the advance was a temporary benefit as investors dumped stocks and put the proceeds into bonds. Besides, interest rates eventually will start climbing and thereby push bond prices lower.

These aren’t predictions, just ruminations to show how the process works. In this spirit, the only asset that possibly looks promising is real estate, meaning REITs (real-estate investment trusts) trading in the stock market. REITs’ return was the worst of this lot in the first half, but much better in the third quarter and especially in the past two weeks. Improvement in the midst of chaos shows auspicious resilience.

Sometimes more detail is needed to hunt for potential clues. But the following table about the U.S. stock market shows that clues aren’t easily extractable from the noise.

Median Market Return
3rd Qtr.1st Half
Large Cap-6.41%1.30%
Mid Cap-7.35%4.07%
Small Cap-9.68%4.54%
Growth-6.02%4.90%
Value-8.65%0.58%
Low Volatility-1.86%-0.18%
Momentum-4.92%5.36%

In almost every instance the stock market fell by more in the third quarter than it rose in the first half. That suggests the market was highly vulnerable to the news about slower growth emanating from China and much of the rest of the world. Unless that news reverses direction, vulnerability is likely to persist for a while.

The one exception is the momentum strategy, which focuses on stocks already moving higher. The strategy magnified the first-half return and cushioned the third-quarter decline. By contrast, the low-volatility strategy exacted an upside penalty in the first half in return for its superior downside protection in the third quarter.