Throughout history, we have generally witnessed periods of time where economic prosperity lifts stock prices as investors pour capital into companies that they feel have the best prospects for growth. This inflationary period is confirmed by a rise in interest rates that sends Treasury bonds' prices lower. Then the cycle reverses and we see a "flight to quality" of investors fleeing stocks for the safety of high quality fixed-income. Therefore, as a strategy to offset volatility, you could pair the SPDR S&P 500 (NYSEARCA:SPY) with the iShares 20+ Year Treasury Bond Fund (NYSEARCA:TLT) in order to smooth out the price swings in your portfolio.
However, the unending stream of Quantitative Easing and Federal Reserve asset purchase programs have now created an artificial bubble in both the stock and bond markets. This historically unique situation is of concern because with both SPY and TLT on their highs, which is going to be the one that breaks first?
If you look at a five year chart comparison of SPY and TLT, you can see that back in 2009 and 2010 these asset classes were moving in a relatively inverse pattern. This is the historical "normal" that confirms the capital flows between these markets do not reach overabundance. However, in early 2011 TLT took off and started trending in the same direction as stocks. This has been a boost of confidence to nearly every investors portfolio, but unfortunately this trend can't continue for much longer.
Now that both of these asset classes are near their all-time highs, investors should be wary about the future dynamic of risk management in their portfolios. Millions of investors around the country have been indoctrinated into a diversified asset allocation approach that may ultimately fail to shield them from the coming storm. Just being 60% stocks and 40% bonds is not going to cut it anymore.
With 30-Year Treasury yields currently sitting right around 2.9%, we are very close to the historical low of 2.5% that we hit last August. This extreme will make it harder and harder for investors to find safety and value in an asset class like Treasury bonds that has traditionally been a safe haven in tumultuous times.
My gut is telling me that we are going to ultimately see at least a modest correction in stocks this year, which may push Treasuries back to their all time lows. With the Fed continuing to keep interest rates artificially depressed (and bond prices high), stocks are probably going to get left out in the cold.
Another asset class that might be the beneficiary of the stock and bond highs is the SPDR Gold Shares (NYSEARCA:GLD). Gold is well off of its 2012 highs and may represent a long-term value and place of safety for investors that are seeking hard assets.
In order to combat the effects of either a stock or bond sell-off in your portfolio, I recommend that you consider the use of a trailing stop loss on all of your ETF holdings. That way, you are able to participate in the current up trend but are protected against a protracted sell-off.
In addition, you should be starting to re-evaluate your asset allocation strategy to include a game plan for the Great Rotation out of bonds and into other asset classes like stocks, commodities, or cash. While this may not occur for several more years, it pays to be prepared ahead of time to safeguard your hard earned money.
Being nimble in a quick moving market will serve you well as we navigate through these very interesting times.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Disclaimer: David Fabian, Fabian Capital Management, and/or its clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities.