Contrarians must be thinking about the sustainability of the year-end stock rally after six weeks of remarkable gains. The most recent AAII Investor Sentiment Survey discovered that a whopping 52 percent of respondents were bullish, far surpassing the long-term trend of 39 percent. Meanwhile, nearly $43 billion of inflows poured into U.S. equity ETFs in the prior month – an amount not seen since December of 2007.
In truth, contrarians would not be the only investor type with reason to question the markets. Consumer spending tumbled 11% over the Black Friday weekend from a year earlier, despite the extra pocket cash from lower gasoline prices. What’s more, those lower oil prices may not be a sure-fire positive for broader equities, particularly if the Fed is serious about raising overnight lending rates. Severe deflation in oil around the globe may ultimately mean lower profits and rising unemployment for energy-related industries (e.g., oil, wind, solar, coal, natural gas, etc.) as well as militaristic strife in Russia or the Middle East.
If stocks are going to falter, as they did in the remarkably brief September-October pullback, how might one profit as well as protect his/her money? Do you have to “short the market” or use leverage? Fortunately, there is an alternative. You can use a diversified basket of unique asset classes – those that are not correlated to broader U.S. equity markets.
Some that I might use in combination? I certainly might add SPDR Gold Trust (ARCA:GLD) into my mix, as well as sovereign debt on foreign exchanges with Japanese Government Bond (JGB) and German bund exposure. I might opt for the greenback via PowerShares Dollar Bullish ETF (NYSE:UUP). And I’d probably pick up zero coupon bonds via PIMCO 20+ Year Zero Coupon Fund (NYSE:ZROZ).
In essence, I’d pursue a wide range of asset classes that, historically, have little to no correlation with equities. This might require replicating the ETFs/ETNs in the the FTSE Mutli-Asset Stock Hedge Index (a.k.a. “MASH”). The “MASH” Index provides an effective hedge against stocks without the involvement of inverse investments, shorting or leverage.
Multi-asset stock hedging does not imply that one cannot see positive returns in a positive year for equities. In fact, the FTSE Multi-Asset Stock Hedge Index is up 5.3% year-to-date. On the other hand, if stocks do have a difficult period, the benefit of multi-asset stock hedging becomes more tangible. For example, the S&P 500 closed at 2011.36 on September 18 before finishing at 1862.49 on October 15. The high-to-low in the September-October sell-off for the popular benchmark was -7.4%. In the same period, the FTSE Multi-Asset Stock Hedge Index (”MASH”) offered 3.3%, without shorting or leverage.
What about more severe stock shocks like the 2011 Eurozone crisis? The S&P 500 dropped -18.8% on a closing basis from 7-7-2011 to 10-3-2011. The FTSE Mutli-Asset Stock Hedge Index (”MASH”) garnered 12.4%.
Do I really think that a bear market is imminent? No, but it is inevitable. And one way to protect, even profit, against an inevitable disaster in equities is through multi-asset stock hedging.
Could a bear market be rapidly approaching? If oil collapsed to $40 per barrel for any meaningful length of time, that might be enough to set the wheels in motion. Think about it. You could see a debt crisis/currency crisis or a militaristic event in Eastern Europe or the Middle East – regions that depend heavily on oil revenue. Equally concerning, with energy company debt comprising 20 percent of high yield junk, bank exposure to the debt might cause trouble for the financial system. Lack of interest in acquiring junk debt may already be a sign of troubles with the liquidity and pricing of the debt down the road.
Keep an eye on the iShares Treasury Bond 7-10 Year ETF (ARCA:IEF):iShares High Yield Corporate Bond (ARCA:HYG) price ratio. If IEF:HYG continues rising the way that it has since July of this year, stocks could be in for an uncomfortable ride. Widening credit spreads and general disdain for the high yield arena tend to foreshadow stock asset woes.
Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.