The last 6 years have been a roller coaster for most investors. The Federal Reserve (Fed) has intervened to create booms and busts. The graph below compares the performance of various asset classes. The orange arrow shows the direction of the stock market as a response to Fed strategy:
The U.S. investor was impacted by booms and busts as follows:
Boom #1: The Fed encouraged banks to lend and thereby created a housing boom. The S&P500 peaked on the back of this housing boom in summer of 2007.
Bust #1: The housing market couldn't sustain the artificial growth and expectedly collapsed. The stock market followed and collapsed in the fall of 2008. The collapse worsened till the trough in March 2009.
Boom #2: The Fed announced QE1 in Nov. 2008 and started by buying $600B in mortgage backed securities (MBS). The stock market responded to this stimulus and started to go up. This QE1 continued till June 2010 and by that time the Fed had purchased $2.1 trillion worth of bank debt, treasuries and MBS.
Bust #2: The effects of QE1 wore off and in May 2010 the stock market started going down.
Boom #3: The markets knew the Fed was friendly and started to demand stimulus. The Fed obliged with QE2 and the markets started recovery in August 2010.
Bust #4: The effects of QE2 started to fade off and the market started to level off and then go down between May to August 2011.
Boom#5: The Fed was so scared of a repeat of 2008, it made an unprecedented announcement to keep interest rates low till 2013. The markets immediately took off.
Performance of various asset classes:
1. Physical gold (GLD) was the best asset class gaining over 150% (went up by over two times and a half).
2. Mining stocks as represented by GDX, Energy stocks represented by VDE, emerging markets (VWO) stayed correlated with an overall gain of around 30%. This was not a bad place to be, as the Fed was busy driving the price of the dollar down with easy monetary policies.
3. Long term treasury bonds and 10 year certificate of deposits (CDs) were another great place to be as interest rates fell by about 40%.
4. The S&P 500 was close to where it was 6 years ago.
From the above history, it is a safe bet to assume that a very market friendly Fed exists. The Fed continues in its quest to create inflation. It wants to fend of deflation at any cost. It has successfully created inflation of commodities as I pointed out in my previous articles. Despite the crash this week, that long term bullish trend in commodities stays intact. For all the risks and the roller coaster rides, the stock market (S&P500) rewarded the investor with 9% gains.
As I recommended previously, the best performance came from a combination of gold with CD's to dampen the volatility from inverse dollar correlation.
What should the investors do and what action should they take?
1. Going forward, Physical Gold, Mining stocks (GDX) and Energy (VDE), are all good places to be. This is because the Fed will continue to be dollar unfriendly and that will continue to be good for commodities over the long term
2. The safest portion of the assets always need to be in laddered 10 year certificate of deposits. Never forget what happened in fall of 2008. That way the investor continues to take advantage of improving interest rates by reinvesting maturing certificate of deposits.
3. For those looking for a S&P500 rebound due to the improving jobs picture, or continued emerging market performance, that may happen. But in that case, the energy sector cannot lag behind. The reason is that the world has not figured out how to grow while reducing energy demand.
Summary: The long term place to be it still physical gold, GDX, VDE and certificate of deposits. These assets form the core part of the portfolio. After the core portfolio percentages are met, very small dollar cost averaging bets can be made on the improving stock market scenario world wide. These could be achieved by investing in S&P500 (VFINX) and emerging markets . But be prepared for a roller coaster ride. During that ride you will be glad your portfolio contains certificate of deposits.