The 8 Most Appropriate Strategies Now

Includes: DBA, DBC, EUO, FXE, PBJ, XLE
by: Roger Nusbaum

Cullen Roche posted the following list from David Rosenberg for this "ailing" market (hat tip to a tweet from David Merkel).

  • Hedge funds
  • Dividend Strategies
  • Long oil, gold, raw food
  • Reduce base metal exposures
  • Short the Euro
  • Defensive sectors
  • Low levels of leverage/risk
  • Focus on quality and liquidity

The list is of course interesting and could be implemented by anyone so inclined, well for the most part anyway.

IndexIQ offers several ETFs that attempt to track hedge fund indexes and there are of course several other absolute return ETPs that are generally in the same neighborhood. These products strive for the same narrow range of outcomes no matter what is going on in the world. Any product that shows the ability to deliver during different market conditions would seem to have utility for any diversified portfolio.

Despite the hornets nest I whipped up at Seeking Alpha, I am all for targeting a dividend yield higher than the S&P 500 (NYSEARCA:SPY) or whatever benchmark you might use, I'm simply not for going all in on any strategy. There are plenty of ETFs that target all manner of dividend ideas and of course countless individual stocks and investment products that offer very good yields. I'm happy if I can add 100 basis points of yield above the benchmark and would be thrilled with 150 basis points (the context being my priority of a diversified portfolio over yield).

The idea of being long oil, gold and raw food would seem to be more of a long term demand story, a long term story I believe in. I guess Rosenberg thinks that even in the short run if his 99% chance of a recession call plays out that stocks in these areas or the underlying commodities will offer relative shelter. That is not an assumption I would make, especially with oil, ag commodities and food related equities. In the last five months of 2008 the PowerShares DB Commodity Index Tracking ETF (DBC) fell 52%, the PowerShares DB Agriculture ETF (DBA) fell 43%, the Energy Select Sector SPDR (XLE) fell 47% and the PowerShares Dynamic Food & Beverage Portfolio ETF (PBJ) fell 16%. PBJ held up pretty well but the others did not offer much protection. That doesn't make them bad long-term holds, they just would not be areas I would expect to help mitigate the downside.

Reduce base metal exposures kind of contradicts the above bullet point. The thinking of course is that base metals are more sensitive to an economic downturn. In the same period referenced in the above paragraph DBB fell 54% so the others held up a little better but I'm not I would say down 47% is much shelter versus a 54% drop (the 16% for PBJ is).

Anyone wanting to short the euro could buy the ProShares Ultra Short Euro (NYSEARCA:EUO), I'm not sure if there are other inverse euro funds. Over the last 12 months the Rydex Euro ETF (NYSEARCA:FXE) is up 18% and EUO is down 32%. While you know the risks of buying levered ETFs by now the 32% drop is pretty close to working long term and of course anyone with a margin account could just short FXE.

Defensive sectors make sense in the face of a recession. If an average bear market decline is 30% for the broad index then it is possible that well chosen stocks from defensive sectors might contain their declines to high single digits. A 9% drop in a down 30% world is pretty optimistic but in general these sectors (utilities, healthcare, staples and certain ma bell telecoms) do go down less.

Lowering risk, or as I might prefer to think of it, looking less like the market after a 90 or 100% gain in just a couple of years will not be the worst thing you ever do in your portfolio.

Focusing on quality can mean all sorts of things with some duplication to the above mentioned defensive sectors and dividend stocks but from the top down it will be difficult to find stocks that go up in the face of a normal bear market/recession decline. Longtime client holding Johnson & Johnson (NYSE:JNJ) went down about 10% in the face of the S&P 500 dropping 38% in 2008, which I think of as being a fantastic result but it was still down nonetheless. Focusing on quality can make for a good relative result (which I am fine with) but I would not expect a good absolute result.

In addition to the above list from Rosenberg I would add seeking out individual countries that are very unlikely to have any fundamental connection to a US economic recession. For example Chile's economy can chug along just fine in the face of a US recession. I would note that if Rosenberg is right on his timing, so soon after the last recession because it is a balance sheet recession, it will probably not be another global financial crisis and so there may not be so many incidents of correlations going to one, less than in 2008 anyway.

Longer term of course I think investors need to isolate other countries with a more promising fundamental thesis than the US, Western Europe or Japan.