Financial professionals are blaming the latest round of risk asset uncertainty on a variety of factors, from the continuing sell-off in oil to the possibility of Greece being kicked out of the euro-zone. Still others are pointing to anxiety over the U.S. Federal Reserve’s intention to raise its overnight lending rate target in mid-2015 – the first move of its kind since December of 2008.
Meanwhile, the biggest names in bonds have added fuel to the fire. Bill Gross at Janus has declared that the good times are over; he anticipates a plethora of “minus signs” in front of riskier asset classes by year-end. Similarly, Jeff Gundlach of DoubleLine believes the U.S. 10-year yield will test 1.38% from its 2.0% level. That is in sharp contrast to the unanimous verdict of economists that the 10-year would be sharply higher; the average expectation is 3.0% by December.
Since the beginning of last year, I have argued the exact opposite and extolled the virtues of owning long-maturity treasuries via Vanguard Extended Duration (EDV) and/or Vanguard Long Term Government Bond (VGLT). The yields on these safer havens have been more favorable than the sovereign debt of beleaguered foreign governments in the developed world. Even today, a 10-year U.S. Treasury at 2.0% compares quite favorably with German bunds (0.5%) and Japanese government bonds (0.3%).
A wide variety of international and emerging market stock assets floundered in 2014, and they have continued to descend in the New Year. Yet it may come as a shock to some buy-the-dip enthusiasts that many U.S. stock ETFs have already broken below key support levels. The ones that I have identified in the chart below are currently below 200-day long-term trendlines (exponential).
|Paradise Lost? U.S. Stock ETFs Begin Falling Below Respective Trendlines|
|% Below 200 Day|
|SPDR Select Energy (XLE)||-17.1%|
|Vanguard Materials (VAW)||-3.1%|
|SPDR KBW Bank (KBE)||-2.0%|
|Market Vectors Morningstar Wide Moat (MOAT)||-1.8%|
|Guggenheim S&P 500 Pure Value (RPV)||-1.2%|
|WisdomTree Small Cap Earnings (EES)||-0.9%|
|RBS U.S. Midcap Trendpilot ETN (TRNM)||-0.9%|
|Fidelity Telecom (FCOM)||-0.4%|
|RBS U.S. NASDAQ 100 Trendpilot ETN (TNDQ)||-0.2%|
|First Trust Internet (FDN)||-0.1%|
While nobody can predict whether the current flight from risk will be yet another head fake – investors have snapped up U.S. stock shares on every 4%-8% pullback since the winter of 2011 – extreme movements in both commodities and currencies in recent months do not bode well for the bulls. For example, dramatic falls in the price of crude oil historically correlate with an increase in geopolitical and economic crises. Does anyone believe that Wall Street can continue to ignore an uptick in overseas strife at the same time that the energy sector is reeling stateside? Similarly, the swift appreciation of the U.S. dollar and the quick depreciation of other world currencies over the last six months is likely to reduce the desire for carry trade activity and/or increase the desire to take some “chips off the table.” In other words, assets like PowerShares DB Dollar Bullish (UUP) can be safe havens from stock turbulence, yet the ripple effects can create a desire for a reduction in risk taking across the board and an increase in desire for U.S. Treasury bonds.
As an advocate for long-duration treasuries since the first week of January 2014 – as one who wrote at great length about the virtues of a barbell approach in a late-stage stock bull – I decided to investigate the unusually high positive correlation of two of my largest holdings, Vanguard Extended Duration (EDV) and Vanguard Dividend Growth (VIG). Historically speaking, treasuries and stocks have a slight positive correlation in good times and a strong negative correlation in bad times. That’s why 2014 represented an unlikely scenario where matching “risk-off” capital preservation with “risk-on” capital appreciation produced risk-adjusted gains that far exceeded stocks alone.