Prepare Your Portfolio For Volatility
Pacific Park Financial Inc. | Sep 23, 2014 07:39PM ET
HSBC’s most recent Purchasing Managers’ Index (PMI) for the Chinese economy rose to 50.5 from a final reading of 50.2 in August. The manufacturing sector may be expanding, but the growth is noticeably restrained. Meanwhile, German factories registered their slowest growth in 15 months and the French manufacturing segment continues to shrink. Equally disconcerting, the Japanese economy declined at its worst annual rate since the mayhem of the global credit crisis in the first quarter of 2009.
Perhaps ironically, some investors anticipate great things out of European and Japanese stocks. The premise? Both the European Central Bank (ECB) as well as the Bank of Japan (BOJ) are likely to provide the kind of monetary stimulus that pushed U.S. equities to all-time record highs. The problem with this supposition? Respective governments are not quite as likely to overcome structural economic weaknesses; that is, creating money to purchase assets, manipulate rates and depreciate currency value might not be successful in sidestepping recessions in Europe or Japan.
China presents yet another challenge. The probability that the Chinese economy is holding up better than the above-mentioned heavyweights might actually reduce the likelihood of the People’s Bank Of China (PBOC) joining the stimulus party. Nevertheless, attractive valuations for Asian stocks should offset economic uncertainty. That’s why I continue to recommend an allocation to Asia through ETFs like iShares MSCI AllCountry Asia X Jap (NASDAQ:AAXJ).
Those who have held AAXJ since February might wish to manage downside risk with stop-limit orders; a stop near a price point of 60 might be your unemotional sell point. Others who prefer to employ 200-day moving averages could reduce exposure if the price of AAXJ falls below and stays below its key trendline.
How might global economic uncertainty affect U.S. stocks in the months ahead? From my vantage point, you should have already reduced or eliminated U.S. small-caps from your basket. What’s more, you should diversify the risk of your large-cap holdings with long-dated U.S bond ETFs. I have maintained this barbell dynamic throughout 2014, using funds like Vanguard Long Term Bond (ARCA:BLV) and Vanguard Extended Duration Tre. (NYSE:EDV) to offset pullback concerns for core holdings such as iShares Core S&P 500 (ARCA:IVV) and iShares S&P 100 (NYSE:OEF). If you believe (as I have believed since the start of the year) that longer-maturity U.S. yields would not rise due to a weakening world economy, then you might see the value of BLV or EDV in your portfolio.
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Those who doubted U.S. bond viability in January – and who still doubt it today – may be missing the big picture. U.S. debt is still regarded as safer than most, if not all, other nations. Moreover, yields for long-term U.S. debt are more attractive than those of other industrialized countries. Even intermediate-term debt comparisons are quite favorable, as the yield of the 10-year Treasury is more than double that of the 10-year German bund. It stands to reason, then, that safety seekers as well as income seekers will still want a piece of the U.S. bond pie.
Let me offer one additional thought about the possibility of a significant correction for the first time in three years. Buying the dips proved beneficial in 2012 and in 2013. It also worked in January and in July of this year. However, the U.S. Federal Reserve had been fully engaged in its stimulus providing, quantitative easing, bond-buying endeavors. The Fed’s intention to end its purchases for good in October is coming at a time when the global economy is weak and the U.S. real estate market is fragile.
Not surprisingly, the NYSE High-Low Index is the latest technical indicator to flash a yellow warning. When the NYSE High-Low Index moves above and stays above 50, one often regards the sign as bullish. When the index moves below and stays below 50 – when new lows consistently outnumber new highs – many regard this as a signal that U.S. stocks have taken a bearish turn. In September alone, the High-Low Index has moved from the low 90s to 50.3.
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