Here in the first week of April 2013, an overwhelming number of folks believe one truth to be unassailable. For worse or for better, the U.S. Federal Reserve's unconventional interest rate easing has pushed dollars into riskier assets, including higher-yielding debt, equities, and real estate.
Beyond crediting the Fed with a modern-day "wealth effect," however, opinions vary greatly. Some expect that the U.S. Federal Reserve's electronic money creation and subsequent bond purchasing will continue for many years into the future. Others postulate that the Fed may signal a change in direction as early as June or July. Similarly, there are those who feel that the end of ultra-loose monetary policy will mark the start of a self-sustaining economy - one where stocks and other higher-yielding assets will continue providing ample reward for the risk incurred. Conversely, there are many who argue that the minute the Fed ceases to intervene, these types of assets will drop like boulders off the proverbial precipice.
Granted, without a reasonable return on cash to be found, institutional investors (e.g., insurance companies, hedge funds, money managers, etc.) may find themselves craving more appealing alternatives. On the other hand, big money can head for the exit doors just as quickly as it had entered. Profit-taking after months of unrestrained gains can knock the wind out of a market's sails. Even a series of less-than-glorious economic reports can put a dent in the idea that the Fed can cure all portfolio ills.
For example, while it has not been widely reported, roughly three-fourths of S&P 500 corporations have issued negative guidance going into the Q1 earnings season. They're likely to blame their "misses" on the ongoing eurozone recession and/or sequestration. Meanwhile, manufacturing growth in the U.S. continues to slow, as the Purchasing Managers Index (PMI) dipped to 51.3 from 54.3 in March.
Maybe the Fed can solve everything with easy money for home and auto purchases. Still, rotating away from sexier growth assets and into less glamorous defensive equities makes more sense to me. Here are three shifts worth of making:
1. Shift From High Beta Real Estate to Less Volatile Real Estate Investment Trusts. For the better part of 2012, investors in iShares DJ Home Construction (NYSEARCA:ITB) and SPDR Homebuilders (NYSEARCA:XHB) may have seemed prescient. Year over year, we're looking at 55% and 35% gains, respectively. Nevertheless, the risks here are beginning to outweigh the rewards. A safer way to benefit from large company profits in residential, office, and retail real estate is through the higher-yielding REITs. Consider Vanguard REIT (NYSEARCA:VNQ) or SPDR Global Real Estate (NYSEARCA:RWO) on a pullback near a 50-day moving average.
2. Shift From Foreign Dividend Names to Domestic Dividend Producers. In theory, I like emerging market dividends. In reality, however, the high-profile names in the emerging market dividend space are not providing value at this time. Shifting away from funds like WisdomTree Emerging Market High Yielding Equity (NYSEARCA:DEM) and SPDR Emerging Market Dividend (NYSEARCA:EDIV) makes sense when current prices are notching lower lows.
Are there less volatile, higher octane funds worthy of rotating into? Yes, one should consider U.S. dividend stalwarts like WisdomTree 100 (NYSEARCA:DTN), iShares High Dividend Equity (NYSEARCA:HDV), and Vanguard High Yield (NYSEARCA:VYM). That said, I'd be inclined to wait for a 4% pullback in the broader U.S. markets (e.g., the S&P 500) before making that allocation. (Note: Cash is not "trash" when you are exercising discipline and patience.)
3. Shift From High Beta Aggressive Sectors to Low Beta Defensive Segments. When an economy is humming on all cylinders, sector leadership is usually concentrated in the high beta cyclicals like tech and energy. Yet some of the most attractive assets in the tech and energy spaces, like First Trust Internet (NYSEARCA:FDN) and SPDR Select Energy (NYSEARCA:XLE), have crossed below key support levels. In contrast, significant defensive ETFs like Guggenheim Defensive Equity (NYSEARCA:DEF) and WisdomTree Equity Income (NYSEARCA:DHS) focus on safer sectors like consumer staples and healthcare.
Once again, one does not need to sell and replace on the exact same day. When you rotate out of a more aggressive ETF, you can wait in cash for an inevitable pullback before redeploying into a new ETF.
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.