There are moments when the media will grab hold of a terrific sound byte and refuse to let go. For example, some blame the recent weakness on yield-oriented assets — investment grade bonds, high yield bonds, convertibles, preferreds, REITs, defensive dividend stocks — on a mythical “Great Rotation.” The popular catchphrase describes a circumstance whereby investors exit bonds for the sunnier shores of high-powered equities.
With the stock market’s recent surge to all-time highs, doesn’t the “Great Rotation” have to be real? Hardly. Bill Gross of PIMCO fame recently stated that stocks and bonds have become highly correlated such that both asset classes gain in price or both lose in price. And then there’s the data itself. During the first quarter of 2013, $69 billion poured into bond funds. Stock funds? Only $19 billion.
In truth, stocks surpassed even the most bullish expectations in the first 5 months of 2013 because institutional money — pensions, registered investment advisers, hedge funds — needed alternatives to lower-yielding treasuries. Retail investors have sat on cash rather than dive headlong into stocks; the asset allocation to equities remains historically low.
Bullish prognosticators remain convinced that the sidelined money will eventually enter the marketplace, pushing stock indexes to extraordinary heights. They are citing the University of Michigan’s consumer sentiment reading as well as the Conference Board’s Consumer Confidence Index as evidence that the economy is strengthening; both gauges hit levels not seen in 5+ years.
Unfortunately, these measures tend to be highest at stock market tops and lowest at stock market bottoms. Indeed, these indicators might even be less beneficial than looking in the rear view mirror. At least when one looks in the rear view, one has an opportunity to avoid smashing into another vehicle.
No, I am not predicting catastrophe. What I am doing, however, is explaining that the U.S. market’s current direction has little to do with a “Great Rotation” or a strong domestic economy. A portfolio that is heavy on stocks will continue smelling like roses or start to smell like dog waste, depending on what the U.S. Federal Reserve is able to do in its containment of interest rates.
Simply put, the last few weeks of market volatility have been driven by a singular concern; that is, will the Fed slowly begin tapering its bond purchases? The mere suggestion by Fed officials that they may begin the process of winding up the program has led to a rapid run-up in the 10-year to 2.15%.
In turn, every yield-sensitive ETF asset in the 10-year’s wake has experienced greater pain than non-income producers:
|Higher-Yielding ETFs Feel The 10-Year’s Sting|
|1 Month %|
|iShares FTSE NAREIT Mortgage REIT (NYSEARCA:REM)||-10.4%|
|PIMCO 25+ Year Zero Coupon (NYSEARCA:ZROZ)||-9.4%|
|SPDR Select Sector Utilities (NYSEARCA:XLU)||-8.5%|
|iShares FTSE NAREIT Global Real Estate (NASDAQ:IFGL)||-7.5%|
|SDPR DJ International REIT (NYSEARCA:RWX)||-7.4%|
|SPDR Barclays Emerging Market Local Bond (NYSEARCA:EBND)||-5.2%|
|PowerShares Emerging Market Sovereign (NYSEARCA:PCY)||-5.2%|
|iShares DJ U.S. Real Estate (NYSEARCA:IYR)||-3.6%|
|SPDR S&P International Dividend (NYSEARCA:DWX)||-2.7%|
|Vanguard Telecom (NYSEARCA:VOX)||-2.7%|
|SPDR S&P 500 (NYSEARCA:SPY)||3.7%|
The answer for some folks has been to move away from yield-sensitive assets and move toward economically-sensitive assets. That’s not necessarily a “Great Rotation,” but the guidance that some are giving constitutes a “sector rotation.” Note: At least a “sector rotation” is visible in the 1-month and 2-month relative strength data.
Nevertheless, shifting to economically strong sectors in the summertime (e.g., industrials, financials, energy, technology, etc.) has rarely panned out historically. Add a manufacturing slowdown in China as well as Australia, a deepening European recession and schizophrenic stock and bond markets in Japan, and you may find yourself taking a bit too much risk for the potential reward.
The better moves? If you have higher-than-desired levels of cash, purchase yield-sensitive ETFs on these pullbacks. You were wondering when you’d get the chance… and now you’re getting it. The Federal Reserve has no intention of ending its dollar printing and subsequent bond purchasing program, but it does want to take the froth off the cappuccino cup. In contrast, if you have had a great deal of success with a number of positions, take a bit of profit via your stop-limit orders. There’s nothing wrong with raising cash to purchase a “wish list” ETF in the near future.
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.