Understand the real reason that the Fed is even talking about raising short-term rates at all. The monetary policy authorities need to bolster the Fed’s arsenal before the next recession, external shock and/or “black swan” event. They are no longer capable of moving from a 5% fed funds rate range down to 1% or 0%. Instead, we’re now talking about maybe – possibly, someday – getting up to 3% before going back to 0% rate policy and a 4th iteration of quantitative easing (“QE4″).
In truth, I doubt that the Fed will ever be able to move beyond 1% before reversing course. Japan has spent the last 15 years stuck at 0.5% or less. That has everything to do with our reliance on zero percent rates and asset purchases with currency credits (“QE”) for six years. Japan made the same error in judgment.
Admittedly, the Fed has been marvelously successful at persuading businesses to buy back their stock shares; they’ve convinced pensions, money managers, mutual funds and real estate investors to stay engaged, enhancing the “wealth effect” for the wealthiest among us. (Yes, that includes me.)
On the other hand, I have seen the same excesses throughout the decades. I witnessed firsthand what happened to Taiwanese equities in 1986 when Taiwan R.O.C. opened its doors to outside investors. The irrationally exuberant run-up met its panicky demise the following year. I warned investors to have an exit approach to the insanity of dot-com euphoria in the late 1990s; I offered the same warnings leading up to the 2007-2009 financial collapse.
In essence, you do not have to be sitting 100% in cash. We still remain invested in core positions such as Vanguard Mid-Cap Value (VOE), iShares S&P 100 (OEF) and Vanguard High Dividend Yield (VYM). Yet we have also raised 10%-25% cash in our portfolios (depending on client risk tolerance) as stop-limit loss orders have hit on both bond and stock positions. We let go of energy investments that did not pan out. We stopped out of longer-term bonds earlier this year. And Germany via iShares Currency Hedged Germany (HEWG) is no longer in the mix of any client.
The result? More cash for future buying opportunities. And that buying opportunity is likely to be far more consequential than a 3% pullback. With only a few exceptions, we believe it is far more sensible to wait for the real deal – a 10%-plus correction and/or a 20%-plus bear.