By most measures, the U.S. stock market is getting overheated. The Price/Earnings ratio on the S&P 500 is above 25, which is at the top end of the historic range. That said, P/Es have been higher, and price action has shown little evidence of a reversal yet. With the uptrend in intact, the recent pullback provides an opportunity to take advantage of the next swing higher in price, should it occur.
The Vanguard Total Stock Market ETF (VTI) is one way to participate. It holds a diversified collection of large-, mid-, small- and micro-cap U.S. stocks. The chart shows a strong uptrend with little evidence of a reversal yet. The ETF peaked on Mar. 1 at $123.73 and has been in pullback mode since. The pullback reached as low as $118.89 on Mar. 27. Over the last year, the ETF has had a tendency to pause after a rally, so a bit of patience on the entry may pay off. Support is near $118 (old resistance) so consider an entry between $120 and $118. A stop loss goes below $116. If there is another up wave, the price target is $124.75. This is a conservative target based on how the price has acted when moving to a new high. A more aggressive, but still reasonable target based on the price tendencies, is $127.50. The exact entry point and profit target used will have a significant impact on the risk/reward ratio of the trade.
The iShares Russell 1000 Value ETF (IWD) is moving in a similar way, but this ETF has a different focus than the Total Stock Market ETF. This ETF holds Russell 1000 components that are more value-based. For example, the holdings typically have lower price-to-book ratios. The trend is up, with support at $111.60. On Mar. 1 the ETF hit a high of $118.74 and on the recent pullback saw the price drop as low as $112.65 on Mar. 27. Consider a purchase between $114 and $113, with a stop loss below $111.60. If the price does head higher, the conservative target is $119.75, with a slightly more aggressive target at $120.50. Once again, the risk/reward on the trade will vary significantly based on the target used and the exact entry price a trader takes.
The SPDR S&P Dividend ETF (SDY) is also in an uptrend, but a weaker one. While VTI and IWD are trading well above mid-2016 levels, SDY is just above those levels. The price is making higher swing highs and lows, but the moves to new highs are typically short-lived. This ETF holds companies that have a long track record of increasing dividends. It has a dividend yield of 2.50%, compared to 2.16% for IWD and 1.82% for VTI. That said, the trends are stronger in IWD and VTI, and on shorter-term trades the dividends are inconsequential. For this one, consider a purchase between $87 and $86, with a stop loss below $85. The profit target is $91.15, just slightly above the Mar. 1 high of $89.92.
The Bottom Line
The U.S. market is looking overvalued by some measures, but trend traders stick with the trend until the price confirms a reversal. VTI and IWD are in strong uptrends, so the pullback presents an opportunity to get in in anticipation of another rally. SDY is still in an uptrend, but it has been tapering off and looks the most vulnerable on a relative strength basis.
Stop losses are used in case the price keeps dropping. There is also the possibility that the price won't reach the entry areas before moving higher again. Only risk a small percentage of account capital on any single trade.
Disclosure: The author doesn't have positions in the ETFs mentioned.