In recent weeks, stock market volatility has been rising due to uncertainty surrounding whether or not the Federal Reserve would curb its money-printing-for-bond-buying program. Yet this week's data coupled with comments by Fed officials should have assuaged fears related to the tapering of those bond purchases. For example, U.S. manufacturing data via the Institute of Supply Management (ISM) logged its worst reading in four years. Similarly, the folks at Bespoke presented research that showed positive economic surprises at a 15-year low. Who is going to claim that the economy is on solid footing with stats like these?
Meanwhile, a governor of the Federal Reserve's board publicly expressed that the 7.5% rate of unemployment understates the scope of the unemployment dilemma. Similarly, Fed Bank of Atlanta President Dennis Lockhart reaffirmed the central bank's commitment to emergency stimulus. So why have erratic price swings persisted into June? Why is the CBOE S&P 500 Volatility (VIX), also known as the "fear gauge," still pushing higher?
Those that have been looking for clues may not need to look much further than Japan. The idea that massive quantitative easing (QE) can cure all stock ills has already taken a super-sized hit in the world's third-largest economy. Both WisdomTree Hedged Japan Equity (NYSEARCA:DXJ) as well as iShares Japan (NYSEARCA:EWJ) have corrected more than 10% from their respective highs in May.
If instability in Japanese equity markets are any guide, the idea that bad economic news is a good thing may not last. Granted, the Federal Reserve may remain active in the manipulation of interest rates. However, investors may someday require evidence that the Fed policy has benefits beyond the rate-inspired recovery in real estate. Either that, or the Fed might need to promise an elixir with more potency than the currently prescribed dosage of $85 billion per month.
How should ETF enthusiasts approach the current market headwinds? First, recognize that sell-offs, pullbacks, and corrections are normal components of any market. The fact that the Dow went 21 consecutive Tuesdays with a gain, or the fact that the S&P 500 had not fallen 5% at any time in the first five months of the year, or the fact that stocks avoided a 10% corrective phase for more than a year and a half, these events represented atypical patterns.
Second, do not get caught holding every ETF in your investment basket. If you employ stop-limit loss orders to secure a big gain, small gain or small loss -- honor them. For instance, a 9% stop on iShares FTSE NAREIT Mortgage REIT (NYSEARCA:REM) created an order to sell near 14.25. While there are plenty of reasons to expect REM to recover and to restore its uptrend, the biggest mistake any investor can make is to fall in love. Honor the stop-limit order to avoid a big loss, park the proceeds and evaluate a wide range of possibilities on your ETF "wish list."
Third, if you believe that economic weakness will be enough of a headwind, be patient in the redeployment of your cash. I am comfortable with dipping toes into low-beta waters, especially if those waters are less tethered to the economic cycle. The iShares High Dividend Equity Fund (NYSEARCA:HDV) is high on that list.
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.