ETF Trends
ETF Trends

This week’s Barron’s had some great quotes, a couple of which we covered in our weekly market update.

The first one was in the Up and Down Wall Street column as follows;

Central bank largess rather than economic growth has buoyed asset prices.

This relates to a quote from John Mauldin a couple of weeks ago;

The measure is the surplus of money that is not absorbed by the real economy. The term is named after the great English economist Alfred Marshall. When the money supply is growing faster than nominal GDP, then excess liquidity tends to flow to financial assets. However, if the money supply is growing more slowly than nominal GDP, then the real economy absorbs more available liquidity. That’s one reason why stocks go up so much when the economy is weak but the money supply is rising.

The idea with these quotes is to create, or reiterate, some context to what has been going on with equities during this bull market.

Every once in a while you might hear a reference to the gains made during the internet bubble as not having been real; obviously many of those gains were quickly wiped out. Given the Fed’s heavy hand in markets for the last six years and the huge gains in equities it seems likely that people will look back on this now 65 month old bull market as not being real.

It will be real to the people who take steps to protect their gains. Anyone who did not panic out in 2008 has reasonably gone along for the ride to some degree but as we saw unfold in 2008 people somehow forgot that the market occasionally goes down a lot (bear market), they react like it has never happened before and are unprepared.

Being prepared for the next bear market, keep in mind this has nothing to do with trying to predict when it will occur, has two meanings. One is emotional which is that as sure as you are reading this there will be another bear market at some point, it will scare the hell out of people, then it will make a low and eventually come back to make a new high despite it somehow being different than all other bear markets before it. Coming back may take years, or not, but it will recover. The great recession was different but followed that exact pattern and as obvious as it sounds now I promise you people will detach from this reality when it happens but the way to avoid that happening to you is to understand how it works, now, while markets are at a high and fear is not part of the equation.

The other meaning is strategic. First figure out whether or not it is suitable for you to take defensive action with your portfolio (for me it is suitable) and then figure out the right way to do it (I prefer relying on the S&P 500’s 200 day moving average) and then sticking to it. That last one is the toughest one for the reason we talked about above. People often come emotionally unglued in the face of declines. In the past I’ve talked about a former client who worried a lot about every decline and invariably the conversation ended with my reminding him that he’d been through more declines than I had.

The other quote to mention comes from Tad Rivelle of TCW who said;

At some point, we are going to be living with significantly higher rates than we have today. Fed policy is suppressing rates. That, in fact, is the whole point of zero rates or quantitative easing. As a consequence, market forces aren’t able to express themselves fairly and properly in the interest-rate market. We do not believe that what the Fed is doing is ultimately going to take us to a better place, so we’ve reined in the portfolio’s duration over several years, and we are defensive when it comes to corporate bonds and high-yield securities.

How much risk are you taking in the income portion of your portfolio? The answer to that question is less important than whether or not you know how much risk you are taking. There’s nothing wrong with loading up on volatility and risk as long as you know you’re doing it.

There is no way to know whether there will be severe consequence as implied in the above quotes but whenever the next really big decline comes for stocks and/or bonds we know certain things; people will over react and panic because of how different it will be. Take the time now to do what you need to avoid being part of that group.

This article was written by AdvisorShares ETF Strategist Roger Nusbaum.