Perhaps ironically, even as an institutional investor, I am not finding myself particularly bearish. On the contrary. I see opportunity to continue riding severely overvalued market-based securities higher; that is, there’s no reason to exit the central bank stimulus bubble when the world’s investors have so much faith in their policies. Overvaluation can beget irrational exuberance, and irrational exuberance can beget insane euphoria. It can go on for weeks, months or years. The only caveat? You have to realize the reality that asset prices have gone rogue, and that you will need an insurance plan for reducing risk when the inevitable blow-up transpires.
My approach is threefold. First, hold the stock assets that continue to trend higher. Each needs to remain above a a significant trendline like a 200-day moving average; a downside breach should not last more than a couple of days. Some of my favorites? Vanguard Dividend Growth (VIG), Vanguard Mega-Cap Growth (MGK), SPDR Select Health Care (XLV) and Vanguard Information Technology (VGT). Additionally, add exposure to assets where you see value, as I have with iShares Currency Hedged Germany (HEWG), or add exposure to where you’ve witnessed momentum, as I have with PureFunds CyberSecurity (HACK).
Second, recognize that the appeal of long-term U.S. bonds will not dissipate in a weakening global economy. Fits and starts? Sure. Yet long-term U.S treasury proxies yield more than comparable sovereign debt abroad. Buying the bond dips can be as lucrative as buying stocks when they pull back. What’s more, funds like iShares 20+ Year Treasury (TLT) and Vanguard Long Term Bond (BLV) have made more money over the last 15 months than ETFs like the S&P 500 SPDR Trust (SPY) or Vanguard Total Stock Market (VTI). (Note: Readers know that I have been advocating exposure to longer-term maturities since December of 2013.)
Third, there are a wide variety of things that could derail the respective rallies in stocks and bonds. Policy mistakes by one or more of the major central banks around the globe could cause an exodus. A monumental shift toward global acceleration in the worldwide economy would likely catch investors off guard. A decline in oil prices below the current line in the sand at $45 per barrel could cause hardship and/or civil unrest in export-dependent countries. A less-than-graceful exit from the eurozone by Greece (at some point in 2014) could affect the investing landscape. Even an unforeseen event(s) could take market-based securities for a ride where the price declines lead to bearish panic rather than bullish dip-buying opportunity.
Recessions as well as accompanying bear markets in equities are inevitable. It follows that one should be prepared to raise cash in their money market allocation to protect capital. I use stop-limit loss orders and trendline breaches to determine when a larger cash allocation is sensible. Yet I also use the FTSE Custom Multi-Asset Stock Hedge Index, sometimes called the “MASH Index,” to potentially earn more than T-bills in the early stages of a stock market bear. Component asset types include currencies (i.e., yen, franc, dollar), precious metals (i.e., gold), foreign sovereign debt (i.e., Japanese government bonds, German bunds) as well as U.S. bonds (i.e., inflation-protected, zero-coupon, long-term treasuries, munis). You can learn more about the MASH Index at StockHedgeIndex.com.