3 Ways To Invest In Stocks (Even When The Ride Is Coming To An End)
By Gary Gordon:
The U.S. economy is appallingly dependent on the âwealth effect.â And the U.S. Federal Reserve knows it.
Just how âeasyâ is the Fedâs monetary policy? The real Fed Funds Rate ((FFR)) is at -0.8% right now. The last time the inflation-adjusted FFR was down at -0.8% had been 8-9 months into the Great Recession (10/2008). Before that, the country had been 8-9 months into the 2001 recession (12/2001).
Pushing the cost of capital to insanely cheap places used to be a tool for alleviating recessionary pressure. Today? The central bank of the United States believes in the permanence of cheap credit to maintain elevated levels of stock, bond and real estate prices.
The proof of financialization is in the bread pudding. Never in the history of the U.S. economy has the ratio of household assets to nominal gross domestic product ((GDP)) reached 4.25.
Itâs not just the reality that asset price inflation is vital to economic wellbeing in 2019. Previous wealth effect reversals occurred because of an over-reliance on respective asset bubbles in stocks in 2000 and real estate in 2008. (See the orange lines in the chart above.)
Unfortunately, most of the Federal Reserve committee members only see the âbenefitsâ of the present-day wealth effect. Few of them show any concern about the eventuality of an ugly reversal.
Never mind the probability that the Fed will not have enough ammunition for a crisis or recession. All-star economists are notoriously poor at alerting folks when a recession is happening. In particular, the average number of months between the inception of economic contraction and a pronouncement by the National Bureau of Economic Research ((NBER))? Nine months.
Granted, people keep on spending in ways that's keeping the current expansion alive. Indeed, the recent 1.9% GDP print was entirely attributable to the resilience of the consumer.
On the flip side, consumers have rarely been as pessimistic about the economic future. The differences between present-day circumstances and future expectations are nearly as bleak as they were leading into the 2001 recession. They are even more stark than they were leading into the Great Recession of 2008.
Businesses already are glum. A broad measure of job gains in a survey by the National Association for Business Economics ((NABE)) is at its lowest level since 2012. Meanwhile, according to Jon Hill at BMO Capital, CEO confidence hasnât been this low without the economy entering recession or already mired in one.
Small companies may be struggling the most. The proportion of non-earners within the Russell 2000 is getting closer and closer to 30%. Jill Carey Hall at Bank of America Merrill Lynch points out that these levels are usually seen during economic downturns.
Of course, none of the troubling specifics imply immediate doom for stocks, corporate bonds, real estate or other risk assets. Chairman of the Fed, Jay Powell, has been keeping the asset price dream alive with three consecutive rate cuts and $60B-plus in monthly Treasury bill purchases - a quantitative easing ((QE)) elixir where the electronic dollar credits eventually find their way into riskier investments.
Think about it. Not only is the FFR stimulus as accommodating as it was during the 2001 recession as well as the Great Recession in 2008, but the Fedâs balance sheet is now back above $4 trillion. (They just keep right on cranking the electronic money printing press!)
Perhaps ironically, capital spending at corporations continues to weaken and earnings continue to slide. It follows that wildly optimistic earnings estimates for 2020 will need to be slashed, pressuring valuations. And those valuations already are pricey.
Can Fed actions and the actions of other major central banks (e.g., European Central Bank, Peopleâs Bank of China, etc.) really keep U.S. asset prices elevated indefinitely? In spite of late cycle indications? Many in the financial media seem to think so.
However, it's more likely that a shock to the system will trigger a wealth effect reversal. And with it, another recession.
Until that time, though, investors still need to allocate a percentage of their assets to equities. Here are three ways that one may do so, even if the stock bull is close to meeting its maker:
1. Defined Outcome ETFs. Would you willingly cap your upside in the S&P 500 over the next 12 months if it meant you would not experience any losses on the first 15% of a market sell-off? The Innovator S&P 500 Power Buffer ETF (PNOV) seeks to track the return of the S&P 500 Price Return Index up to 8.75% (10/31/19), while buffering investors against the first 15% of losses over the next year (11/1/19-10/31/20).
The cap and the buffer already have changed from PNOVâs inception. At the moment (11/4/2019), with stocks gaining ground on 11/1 and 11/4, the cap is 8% and the buffer is 15.5%. The downside before the buffer would kick in is -0.72%.
2. Trend ETFs. Some folks would prefer to capture all of the marketâs upside potential. After all, who knows how âbubbliciousâ equity indexes will get in the year ahead. Still, is there a mechanism for protecting gains or limiting losses within an equity investment itself?
Enter Pacerâs Trendpilot US Large Cap ETF (PTLC). As long as the market is trending higher, youâre in there. Should a short-term market downtrend develop, PTLC pares back some of its equity exposure. And if the market signals a longer-term downtrend? PTLC shifts its allocation to the safety of Treasury bills.
I'm a fan of paying attention to technical trends. Long-time readers know that I'm particularly fond of the slope of the S&P 500âs 10-month simple moving average ((SMA)) as well as its monthly close. The monthly close on the 10-month SMA helped me sidestep the bulk of the carnage in 2000 as well as 2008.
3. Value ETFs/Dividend Aristocrat ETFs. Itâs not that value stocks and dividend aristocrat stocks represent bona fide bargains. Rather, they are relative bargains to the growth stock bonanza that has characterized this decade.
If youâre like me, and you think that the Fed will not be able to override the business cycle altogether, then you might appreciate the SPDR S&P Dividend ETF (SDY) for tracking the total return performance of the S&P High Yield Dividend Aristocrats Index. (The âaristocratsâ in this index have a 20-year track record of consecutive dividend increases.)
From a technical perspective, the SPDR S&P Dividend ETF (SDY):Nasdaq 100 (QQQ) price ratio is showing a âbottoming processâ for SDY. Going forward, SDY is likely to outperform.
Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, Pacific Park Financial, Inc, and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.