"Avoid the crowd" should be one of the first rules for investors. Judging by the size of the throng that has been gathering for the past several weeks under the "things are getting better" banner, it may be time to head the other way and prepare for the possibility that things will get worse fairly soon.
The VIX index is one market barometer that is giving off feel-good signals. It recently closed at about 14, some 66% below its year-ago level. That figure doesn't need much interpretation: investors are extraordinarily complacent about the level of risk in stock prices, a situation that should send a signal to everyone's inner contrarian.
Another put-on-a-happy-face argument has to do with the housing market. Many media outlets and some economists are trumpeting upturns in prices and new housing starts that, on closer examination, are little more than bumps along very low bottoms. Moreover, a look into the future isn't much brighter. It doesn't take much imagination to foresee what will happen to supply if holders of distressed properties now being held off the market, and would-be sellers who have been on the sidelines, begin to put out "For Sale" signs.
The likelihood that difficult times will persist in the real estate market is not good news for the Federal Reserve. The central bank has staked a great deal on the latest round of quantitative easing, which is designed to further expand the Fed's balance sheet for however long it takes to spur asset prices, including home prices, and real economic activity.
Unfortunately, the Fed has pursued the same hyper-expansionary policy for years without success. Nothing suggests that things will be different this time around, or that more money-creation will help to bolster corporate profits. That's because the "transmission mechanism" that directs credit into investments that produce goods and services remains clogged, and the politicians and regulators who have the power to clear the blockage aren't doing so.
Nonetheless, investors seem to be happy, at least for now, with the massive, coordinated binge that central bankers around the world announced in September. The European Central Bank started the latest party by saying it would buy unlimited gobs of euro-debt, the Fed followed suit by launching "QE to Infinity," and the Bank of Japan joined in by upping the amount of assets it will purchase.
When will investors realize that monetary policymakers are providing far too much of a potentially harmful thing? Perhaps the answer is "later," if the inflationary consequences of the immense liquidity build-up take a while to work their way into the real economy, which is slack and getting slacker. Under those circumstances, and with few positives on the horizon, it wouldn't be surprising if the major stock indexes continued churning near their current high levels as investors wait anxiously for a sizable setback. Under those circumstances, it might be a good idea to take some recent profits and park the proceeds in good-quality corporate bonds with comparatively high yields. Another place to park profits, particularly if the stock market party continues for a while longer: SPLV, the PowerShares S&P 500 Low Volatility ETF, which provides a yield of roughly 2.9% and is reasonably liquid (average daily volume is just under 1 million shares).
But the realization that it is time to pay the piper for monetary profligacy could well come "sooner," and the list of possible triggers is long. If prices for commodities surge in the wake of more central-bank easing, economic activity and earnings growth in the US and elsewhere might slow enough to spark serious worries about The Great Recession, Act Two. Or, investors might finally acknowledge that politicians, bureaucrats, and central-planners have neither the will nor the ability to make the hard decisions that need to be taken. A third possibility is that a political, social, or military flare-up increases the already high level of risk in the global economic and financial systems. And there always is the chance that the never-popular black swan will glide back into view.
Whatever the catalyst proves to be, investors should keep in mind that once the "things are getting better" crowd starts to thin, it could thin very quickly. If that were to happen, investors would want to be nimble, work with stops to protect profits against sharp counter-trend rallies, and concentrate on very liquid vehicles. Investors could participate in a jump in volatility by using VXX, the iPath S&P 500 VIX Short-Term Futures ETN, which trades an average of more than 40 million shares a day. A leveraged EFT such as the ProShare UltraShort S&P500 SDS (about 16 million shares) would do well in a sharp stock market sell-off. Both vehicles, along with many similar investments, are currently selling at or near their lows for the years. And don't neglect gold, which is in a seasonally strong period and has been shining brighter since central banks announced their liquidity surge. GLD trades almost 9 million shares a day.