Will the Bernanke Bubble Burst The Value Of Your ETF Portfolio?

Over the last two years, any investor who has attempted to diversify his/her portfolio has effectively been punished. PowerShares DB Commodity Tracking Index (DBC) logged a dismal -14%, iShares MSCI Emerging Markets (EEM) registered -12%, and PowerShares DB Precious Metals (DBP) posted a horrifying -29%. Could you have added significant value to your U.S. stock holdings with fixed income? Not really. Vanguard Total Bond (BND) proffered a dismal 3.8% over 24 months while SPDR Barclays International Treasury (BWX) served up -2%.

In essence, most asset classes have been frustrating, if not downright disappointing. The U.S. stock market has been the singular saving grace, where Vanguard Total U.S. Market (VTI) has amassed 32% since mid-July of 2011.

So what might we make of the 2013 record highs for U.S. equities? Many fundamental analysts trumpet the fact that price-to-earnings ratios (P/Es) for the major benchmarks are much lower today than they were during the 2000 and 2007 peaks. One might argue that this provides a tailwind for the Dow and the S&P 500 to continue appreciating in value. In 2000 and in 2007, however, diversification across asset classes provided a decrease in portfolio volatility as well as an increase in risk-adjusted returns. Not so in 2013.

Perhaps more disturbingly, the debt-to-GDP ratios of world powers were much lower at previous stock market record peaks. Right now, most of the developed world is technically insolvent. Additionally, the U.S. Federal Reserve of the late 90s and mid-2000s did not need to prop up stocks with $85 billion per month in government bond purchases. On the contrary… stocks during those bull market periods gained independently of Fed policy.

In essence, those who have argued that the U.S. is in better shape in July 2013 than at previous stock market peaks are ignoring the credit-worthiness of sovereign debt, the unattractive nature of alternative assets as well as contrarian data that point to irrational enthusiasm. Long-time economic bears Nouriel Roubini and David Rosenberg have both flip-flopped. At the start of May 2013, after 4 years of “doom-n-gloom,” Roubini advised investors to buy stocks for about 2 years due to ongoing Fed rate policy. Rosenberg has also thrown in the towel, reversing his multi-year claim that bonds were the best place to invest. In other words, when the most prominent bearish naysayers scream “Uncle,” the good times may be nearing an unceremonious conclusion.

Granted, that may sound like I am predicting imminent trouble. In truth, I do not believe that the flip-flopping of vocal bears nor the decline in gross world product (GWP) nor unsustainable debt loads around the globe are going to pop the Bernanke bubble. Not yet, anyway. Irrational exuberance in tech stocks lasted for many years before the demise of dot-com hysteria; irrational excitement for highly leveraged real estate carried on for many years before the financial crisis came to head.

In sum, as long as the world’s investing community has faith in the U.S. Federal Reserve — as long as it places a premium on the greenback as well as the 10-year Treasury — the Bernanke balloon can continue to fill with gas. I will be buying dips; most institutional money managers will be doing the same. After all, with U.S. stocks behaving like the only game in town, and the Fed buying bonds through the 2014 mid-term elections, the U.S. stock uptrend should ultimately overcome any near-term resistance.

Unlike those who may chase the performance of the fastest runners, however, I’d rather build in a measure of safety. (After all, diversification is not making portfolios safer.) I value the lower beta volatility of the health care sector and its limited rate sensitivity. I am continuing to add to positions like Market Vectors Pharmaceuticals (PPH) and iShares DJ Healthcare (IYH). I also prefer tried-and-true dividend payers in iShares High Dividend Equity (HDV). When possible, use the 50-day moving average as an entry point, and employ a stop-limit loss order for protection.

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.