ETF Risk Management in a Strong Dollar World

In spite of maintaining a classically moderate level of exposure to U.S. equities, I am remarkably cognizant of the risks associated with the late-stage stock bull. The business cycle? Not only is it long by historical standards, but honest efforts to tighten monetary policy could prompt its expiration. The almighty buck? If it does not level off soon, U.S. corporate profits earned abroad will be eviscerated by dramatically lower currencies. That leads to lower earnings estimates, higher valuations and, eventually, a stock bear.

In the current year, I do not believe we will see honest monetary tightening endeavors. Job data have been misleading. The U.S. economy has been decelerating. And the current FOMC members are more likely to endorse a Kentucky Wildcat “one-n-done” hike in 2015, as opposed to obliterating the apple cart. Saving face by declaring some sort of moral victory on leaving zero percent rate policy behind? That they will do. Genuinely push for normalization of interest rates in a rapidly rising dollar environment? In a decelerating economy? That’s not likely.

Even though I reduced exposure to Vanguard Extend Duration Treasury (EDV) due to the execution of stop-limit loss orders, long-maturity treasuries are still worth acquiring in funds like iShares 10-20 Treasury (TLH) and iShares 20+ Treasury (TLT). Both benefit from economic weakness and/or market-based uncertainty. Both exhibit enormous relative value against comparable sovereign debt around the globe. Both held respective 100-day intermediate-term trendlines. And both effectively hedge stock risk.

TLT 100 200

Ironically, risk in late-stage bull markets typically becomes an ill-fated notion of missing the rally. People are people, subject to the psychology of fantastical fervor. In truth, risk is the probability that something will go wrong and endanger one’s capital. Protecting against the devastation associated with bearish declines – financial, mathematical, psychological – is the primary task in risk management. If you’re leaving the role of risk management to the diversification gods, you’re nearly certain to find yourself in a hole that is too deep for anything more than prayer.