2 ETFs to Play This Year's Deja Vu Market

Includes: HYG, REM
by: Todd Feldman

I previously wrote an article on Seeking Alpha about how the U.S. stock market in 2011 appears to look very similar to that of 2004. The analysis was based on BFIA's proprietary measures. We were fortunate enough to be able to obtain data to calculate the measures going back to 1970.

Let us compare our current 2011 BFIA measure for the U.S. stock market to our past measure starting in 1970. If we do so, we find four periods where the measures match to today, 1977, 1994, 1986, and 2004.

Figure 1: BFIA Sentiment Measure: 1970 to 2011

Out of these four periods, 1977, 1994, and 2004 resemble 2011 the best since these periods were post-recession periods. In 1977, the S&P 500 declined over 10% while in 1994 and 2004 the S&P 500 rose modestly.

Let us look into these periods further by taking a look at two distinct phases in the U.S. stock market, 1950-1982 and 1983-2011. What we are trying to do is to identify where we are in the investment cycle. Even as financial markets evolve, similar cycles appear over history and if one can identify where we are in the cycle then that information can be used to form an optimal portfolio.

Figure 2: S&P 500: 1950-1982

In figure 2 it can been seen that there occurred a bull market from 1950 until 1967. During 1968, a market peak occurred and the market remained flat for 13 years until the middle of 1982. From 1973-1975 the S&P 500 declined approximately 45% and then rebounded in 1976, increasing approximately 65%. This was very similar to the most recent financial crisis and recovery. In 1977, the U.S. stock market declined after the huge recovery in 1976 and with the backdrop of the 1977 oil crisis. From 1978-1981 the U.S. market remained in positive territory, although with slow growth.

Figure 3: S&P 500: 1983-2011

In figure 3 it can been seen that a major bull market occurred from 1983 to the end of 1999. From 2000 to the present, the markets remained flat. There was a recession in 1990 because of the savings and loan crisis and housing bust similar to 2007-2008. A recovery occurred between 91-93. During 1994, the markets were relatively flat and then a major bull market occurred with the innovation of the Internet.

In 2000 we saw a tech bubble and crash. The market continued to decline until the end of 2002. The year 2003 saw a nice rebound. In 2004 the markets were up and down, remaining relatively flat until the last two months of the year. After 2004 a small bull market occurred.

After reviewing these periods it looks as if we are in the year 1977 of the 1968-1982 investment cycle. If we are to continue on that path, then this year will be a down market and the next 2-3 years we will see modest gains until another major bull market cycle occurs.

What does this mean for your portfolio? Either way we look at it, 1977, 1994, and 2004 did not see impressive returns. The markets were down, flat, or slightly up. This means we do not expect any more great price appreciation from any markets worldwide. Therefore, it is best to invest in high yield assets as these assets will offer income while prices remain flat. Some ETFs that offer nice yields are HYG and REM. A portfolio of high yield securities with a large exposure to energy we believe is the right portfolio for this year.

Disclosure: I am long HYG, REM.