I am ecstatic that the majority of my client base had 65%-70% long exposure in lower-volatility stock ETFs over the last two trading sessions. The S&P 500 picked up roughly 4.5%, which means that these portfolio balances rose approximately 3.0% since the U.S. Federal Reserve promised to be “patient” with respect to raising overnight lending rates. Many of the core holdings – iShares USA Minimum Volatility (USMV), SPDR Select Sector Health Care (XLV), Vanguard High Dividend Yield (VYM) – are the same ones that I have held since December of last year or longer.
Yet I am equally elated that I offset global economic risk with a barbell approach to late-stage bull market investing. Extraordinary stock bullishness may have hammered extended duration U.S. Treasuries on Wednesday and Thursday, but Vanguard Extended Duration (EDV) remains in a long-term technical uptrend. It is also up 40.4% year-to-date; the S&P 500 has been far more volatile on its way to 10%-plus in 2014.
The questions that need to be addressed as investors gear up for 2015 are: (1) Can the U.S. economy continue to accelerate if the rest of the world continues to decelerate, (2) Is it sensible to ratchet up one’s exposure to U.S. stocks as though U.S. stock overvaluation no longer matters, and (3) Is it wise to ignore signs of amplified exuberance? I will address these inquiries one at a time.
1. Can the U.S. Economy Continue to Accelerate if the Rest of the World Continues to Decelerate? The answer is, “Not a chance.” Either the U.S. will succeed at hauling the rest of the globe out of its collective ditch, or the rest of the globe will drag the U.S. down into the deflationary hole.
Do not fall prey to those who write eloquently about the unique nature of the U.S. economy – one that can magically sidestep the world’s troubles as though it exists on a self-sustaining island. Not only is history quite clear on the U.S economy’s inability to expand at accelerating rates when the European and Japanese economies are weak – not only does weakness in emerging areas from China to Russia to Brazil to the Middle East increase the risk of geopolitical shocks – but the U.S. economy is expected to thrive while the Federal Reserve looks to slowly tighten monetary policy. Equally concerning? Bank of America anticipates that monetary stimulus from the easing in Japan and Europe would only offset about one-third of the lost stimulus from the U.S.
From my vantage point? The economic environment in developed and under-developed nations may actually show some signs of improvement in the years ahead, but the U.S. will revert to its mean growth (2%) of the 21st century. There can be no “renaissance” when central banks distort natural cycles of expansion and contraction.
What does this mean for the investor? Perhaps ironically, it may force the Federal Reserve to be unnaturally patient – so accommodating that any modest increase in rates will be quickly reversed by year-end 2015. Safe havens like iShares 10-20 Year Treasury (TLH) will continue to provide value and 10%-plus corrections should prove to be reasonable entry points for overvalued, albeit, well-diversified stock funds like Vanguard Value (VTV). As always, I recommend protecting those buy orders with stop-limit loss orders.
2.Is it Sensible to Ratchet Up One’s Exposure to U.S. Stocks as Though U.S. Stock Overvaluation No Longer Matters? Of course not. Nevertheless, scores of writers and “talkers” have completely dismissed the mountain of overvaluation evidence with empty statements like, “Lower interest rates justify higher stock prices.” That may be true on the surface, but it is not true when stock prices are 50% above the historical average for cyclically-adjusted P/Es.