Indeed, policy makers at the Federal Reserve appear to have boxed themselves into a corner. They hitched their rate-hiking wagon to headline unemployment and they’ve practically guaranteed moves to tighten in 2015. It follows that if the rest of the world is aggressively easing while the Fed is modestly tightening, the U.S. dollar may continue to climb. By extension, it is hard to see how the relationship between the dollar and U.S. stocks will change from the pattern depicted in the chart above.
One should anticipate a 10%-plus U.S. stock correction in the months ahead. One should not expect the Fed to deviate from its implicit and explicit guidance, at least until a corrective phase comes to fruition. At such a crossroad, Janet Yellen’s Fed could offer up a dovish blink; a Federal Reserve Open Market Committee (FOMC) member could emphasize a significant modification to the pace of overnight lending rate moves. Heck, if a correction begins turning bearish with enough ferocity, members might mention freshly discovered threats to the domestic economy. With that, they might stop the talk of raising overnight lending rates altogether, or even hint at a need for a more neutral or accommodating posture. Anything is possible (even an actual recovery in Europe and/or Japan).
At this moment, currency-hedged foreign stock ETFs represent the only dip-buying opportunity in the equity space. I have been adding exposure to iShares Currency Hedged Germany (HEWG) and/or WisdomTree Europe Hedged Equity (HEDJ). You get stock momentum, the dollar over the euro, as well as investor faith in quantitative easing experimentation. (”Hey, it worked for the U.S., didn’t it?” he said sarcastically.)
Finally, do not rule out further flattening of the yield curve. I might have reduced some exposure to extended-duration treasuries due to my investing discipline. Still, it is not inconsistent to expect long-term rates to fall even as short-term rates climb, especially if U.S. stocks react poorly to Fed tightening. Even economic under-performance and/or geo-political unrest would benefit longer-term Treasuries.
Investors looking to buy any dips might concentrate some cash in iShares 10-20 Year Treasury (TLH), a component of the FTSE Custom Multi-Asset Stock Hedge Index (MASH). TLH appears to be holding onto support at its intermediate 100-day trendline.
