Even worse, the brightest minds in the world missed the 2008 recession completely. All that one has to do is to look back at Federal Reserve meetings from 2008. Each of the committee members had extraordinary confidence that the Bear Stearns bailout earlier in the year marked the lowest ebb for risk assets as well as the economy. In June of 2008, Janet Yellen expressed that strong spending data eased her fears about the onset of a recession. She also anticipated raising fed funds overnight lending rates starting in December of 2008. (Note: Chairman Bernake’s Fed went in the opposite direction instead, ushering in zero percent rates and emergency “QE” stimulus.) Similarly, committee member Lacker felt that the outlook for growth had edged up and that risks of a serious recession had receded. Meanwhile, member Bullard believed that the committee should down-weight systemic risk concerns going forward.
Think about it. A minority of folks (myself included) went on record to say that a recession is a near-certainty as early as January of 2008. Meanwhile, smarter men and women — folks who are responsible for monetary policy that affects the entire globe — believed the economy was on track for success in June of the same year. They believed they had solved the world’s financial woes and, by extension, economic uncertainty, with the bailout of Bear Stearns. Yet as late as June of 2008, the Fed had no idea that the precipitous decline in housing prices/sales coupled with the sub-prime drama playing out on Wall Street had the power to send the global economy into a tailspin.
The point of this commentary is merely to stimulate thought. Are we placing too much faith in central bankers? And at what point might we want to consider the possibility that a significant institution (e.g., Federal Reserve, Bank of Japan, European Central Bank, etc.) could make a serious policy mistake?
Here is the way that I’ve been managing the above-mentioned risks with clients of Pacific Park Financial, Inc. I have been reducing the duration of longer-term high yield bonds, since they often move in the direction of stocks. There is plenty of yield in shorter-term high yield ETFs like SPDR Barclays Short-Term High Yield (SJNK) and PIMCO 0-5 Year Short-Term High Yield (HYS). Simultaneously, since the beginning of the year, I have increased the duration on investment-grade U.S. Treasuries and corporate credit. Not only has it been highly profitable to shift toward funds like Vanguard Long-Term Bond (BLV) and Vanguard Extended Duration (EDV), but these ETFs act as a safer haven in times when the stock market is reeling.
Next, searching for stock ETFs with better fundamentals in an environment where the monetary authorities are increasing their stimulus measures has been a recipe for success since 2009. For example, the European Central Bank (ECB) is on target to continue lowering rates and/or provide unconventional measures to battle regional deflation. Granted, the ECB could easily make a policy misstep along the way, and the eurozone itself could struggle to break recessionary pressures. On the other hand, selecting European assets that offer higher dividend yields and trade at significant P/E discounts to comparable U.S. equities may act as a buffer to widespread selling. I continue to favor ETFs like iShares MSCI EAFE Value (EFV) and WisdomTree Hedged Europe Equity (HEDJ).
Finally, there’s simply no substitute for recognizing the power of probability. Perhaps U.S. stocks in the S&P 500 can continue to trade above a 200-day moving average for much longer than 400 days; it broke the record of 385 days a few weeks ago, but maybe it can run for 500 days. And 32 months without a correction may just be marking the end of the 2nd period in a Stanley Cup Final; we might be setting up for a run at 48 months. Nevertheless, intelligent ETF investors should be mindful of the many techniques in their toolbox for insuring a portfolio, including stop-limit orders, trend analysis, hedging and/or put options. Holding-n-hoping is only a “plan” for those who lack knowledge about mathematics, the psychology of human beings and the history of market benchmarks.