Perhaps ironically, widening credit spreads is not the only cautionary sign for stocks. In September, high-yield bond losses had been accompanied by emerging market stock declines, commodity price depreciation and small-cap underperformance. Emergers and commodities may be bouncing back due to rate cut stimulus in China – its first in two years. However, small-cap underachievement via iShares Russell 2000 ( IWM) has reappeared here in November. (See the price ratio below.)
Again, I am not calling for a bearish retreat. We may see an increase in volatility. We may see end-of-the year window dressing. We may even see a rush to get involved by retail investors with too much cash on the sidelines.
Nevertheless, I believe it is critical to have an exit strategy and/or a beneficial hedge to reduce the risk of a crack in one’s stock armor. The barbell approach using long-dated Treasuries has been an effective hedge throughout the year. In fact, long maturity bonds of this nature are part of the FTSE Multi-Asset Stock Hedge Index that I recently developed and introduced. Another means for tackling stock uncertainty is through the disciplined use of stop-limit loss orders and trend analysis.
Keep in mind, hold-n-hope only looks good near the top of the mountain. Stocks may be a primary wealth-building ticket, but the math behind 50% bear market disasters adversely impacts one’s ability to maintain a standard of living in retirement. Financial freedom is rooted in eliminating the big loss.