We have recently witnessed a monumental dilemma on a par with ancient Greek legends. Greece is the birthplace of democracy, the Olympics, artistic realism and most of the core ideas associated with modern Europe. Concurrently, the Graeculī are also perhaps the first true capitalists: known as wheeler-dealers par excellence since ancient times. The European Union is a similarly iconic culmination of two thousand years of starry-eyed dreaming by every European intellectual about a peacefully united Europe. The "no" vote might have consigned Greece to the fringe of not-quite-European nations. And yet, a "yes" vote on the original referendum could have been almost as unfair as to slash pensions for every Louisiana resident after Hurricane Katrina--with little proportional hardship for other US states. In addition, neither "no" nor "yes" comes with any guarantees of actually resolving the problems either of Greece or of the EU. Greece now has an agreement to remain in the EU--but it remains doubtful whether Greece can pay its debts--and this is only one of several major complications. (Graphs courtesy of Finance.Yahoo.com.)
What does this mean for US-based investors? In a nutshell, it means that we should be thankful for being what every investor should now want to be: US-based.
It is often emphasized how inter-dependent the major investment zones are--but seldom emphasized how much they also compete to attract investment capital. We have just experienced clear evidence of our inter-dependence. At the far end of Europe, Greece officially delivered a not-very-surprising announcement that it could not pay its debts. Consequently, the US-based S&P 500 (NYSEARCA:SPY) suffered a one-day drop of -2%--four times greater than normal. This completed a total drop of -3.5% from a short-term peak on June 22. However, the drop did not go significantly further. Every day of the next two weeks saw entertaining but indecisive zig-zags--ending with a consistent daytime upswing on Friday, July 10. This was followed by news of an EU agreement. So long as the news remains hopeful, a prompt rebound seems underway for US-based stocks.
Perhaps for some time to come, we can expect all stock prices worldwide again to bob up or down depending on certain votes cast in the nation that invented voting. If so however, perhaps we have already seen a summary-in-microcosm of the likely long-term results: a startling but ultimately minor change.
Regardless of the status of Greece, we are sooner-or-later likely to see a full-scale correction in the region of -20%. Therefore, keep your Stops cocked. However, even if there is a severe downturn, the prevailing willingness to remain invested during the past two weeks should encourage us to expect a typical rebound pattern in spite of continued uncertainty.
Furthermore, US-based investors can find hope in the fact that so far, the EU always finds its way. As well as the fact that the EU has now proven rather conclusively that--although not always the most profitable place to invest--the USA is the safest place to invest.
Aside from the US and the EU, the only remaining economic super engine is what I call the Chinazone--a.k.a. the "emerging markets" for which an MSCI index invests about 1/4 in China and 1/4 in South Korea, Taiwan and India. The economy of China by itself is already equal to the USA in size as well as potential. Nonetheless, metaphorically speaking, China is still rather dependent on how many orders it receives from Wal-Mart (NYSE:WMT). Or, one might say, in the late adolescent phase of a teenager with a job but living at home. A China ETF or an Emerging Market ETF might outperform SPY in the long run. Meanwhile however, the Emerging Markets are relatively unstable and under-regulated--almost certainly resulting in more of a roller coaster than US-based investments.
Perhaps the island empires of Japan and the UK should also be mentioned. However, in addition to being subject to their own severe uncertainties, Japan and the UK are "holding joint accounts" and "living together" with the Chinazone and eurozone respectively--similar to the way that India is somewhat tied to China, in spite of never having a church wedding.
Brazil could perhaps be somewhat of a safe haven. Brazil's southern-hemisphere economy is well diversified and routinely does well at times when the US and EU are out of season. However, the GDP of Brazil is less than half that of India, which is less than half that of China or the USA. For most US-based investors, the primary significance of Brazil is perhaps not directly as an investment, but merely that it adds to the security of the world in general and of the US region in particular.
For the foreseeable future: on the whole, neither the eurozone nor the Chinazone can do well unless the USA does well. Anything that hits the USA will often hit the others harder. Meanwhile, the others have their own issues from which the USA is relatively insulated.
Perhaps most fundamentally: the USA has Canada as a huge neighbor to the north, which is totally friendly, politically stable and resource-rich. For the EU, Canada is replaced rather exactly with Putin, a veritable "neighbor from hell." (Photos: Zak Efron in Bad Neighbors, denofgeek.com. Putin as himself.) In addition, the USA itself is of course relatively resource-rich.
The USA also has an idyllic resource in high-quality low-cost labor from Mexico. Unfortunately, our politicians seem split between those who want to keep poor Mexicans out and those who want to make them US citizens. Either way, nobody seems to believe in enabling Mexicans to be proudly Mexican. Hopefully, the US someday will instead make Mexico economically stable as well as eternally grateful--simply by viewing Mexicans as neighbors and human beings--therefore giving every honest Mexican a work visa for a crummy underpaid job who desires a crummy underpaid job. Meanwhile perhaps, incidentally returning some US industry to US shores. US-born workers, in exchange for losing factory jobs to Mexicans that they otherwise have already lost, might be given higher minimum wages at the retail outlets where they already work. Meanwhile also making it in the direct interest of every Mexican politician and legal migrant worker to combat illegal US immigration, whether originating from within or without Mexico. Therefore converting all of Mexico from a giant security liability into a giant security fence for the USA. Someday, perhaps.
Meanwhile, US-based investors who seek to maximize either gains or excitement can already choose from a myriad of high-volume and low-spread (hence Stop-friendly) and broad-based (hence bubble-resistant) US-based ETFs which often outperform the S&P 500 and all can be viewed as variants of it. The CRSP US Small Cap Growth Index (NYSEARCA:VBK). The S&P US Retail Index (NYSEARCA:XRT). The Guru Index which copy-cats leading US hedge funds (NYSEARCA:GURU). The IPOX-100 US IPO Index (NYSEARCA:FPX).
For those willing to take on extra risk and extra short-term tax rates, there are also two ETFs for derivative-based indexes which essentially magnify the ups-and-downs of the S&P 500: the S&P 500 VIX Mid-Term Futures Index (NASDAQ:ZIV) and the S&P 500 VIX Short-Term Futures Index (NYSEARCA:SVXY)(NASDAQ:XIV). (I prefer SVXY to XIV for the sake of custodial diversity. ZIV and XIV are in the same fund family.)
Be warned, ZIV and SVXY are extremely volatile. Also, they may self-destruct during a 2008-level downturn--possibly just after being rebought. However, the smaller the allocation, the less the proportional risk. For example, allocating 10% for ZIV and SVXY causes 90% of above-average gains during high-gain periods to be rebalanced into safer positions before the high-loss periods.
There is also a VIX-based market-hedging ETF which is highly stable and normally about 85% non-derivative (NYSE:PHDG). In my current opinion, PHDG works best if held only during bear markets--and with no more than 25% of account value because it is not a high security investment. Several Seeking Alpha contributors have written informatively about VIX-based ETFs. "Are VQT And PHDG Investments Or Hedging Tools?" by Fred Piard, 2013. "How Does VelocityShares Daily Inverse VIX Short-Term ETN Work?" by Vance Harwood, 2014.
I caution against resorting to corporate bonds, municipal bonds, annuities, money market accounts or CD's. Even if FDIC-insured, the FDIC is not necessarily more secure than Fannie Mae or Freddie Mac: federal bailout is optional, not required. (See: "The Confiscation Scheme For US And UK Depositors," by Ellen Brown, 2013.) Quasi-safe investments are like a wooden fire escape--apparently safe, but only so long as there is no major fire. Once your money is lost, it makes no difference that the investment was supposedly "low risk." Corporate bonds might make some sense for the multi-millionaire who can afford losses. However, for the average investor, it is better to divide the portfolio between investments that have a strong benefit-risk ratio (broad-based US equity ETFs) and investments that are truly maximum-security (short-term TIPS ETFs or a TIPS ladder). What is the point of a low-paying investment that forces you risk a much higher percentage of savings--becomes less safe the more shaky the economy--and cannot instantly be shut down if the economy threatens to collapse--and indeed is supposedly intended as something to hold on to with white knuckles? Quasi-safe allocations are an outmoded convention from a time when ETFs did not exist--when a "discount broker" charged something like $50 instead of $5 per Stop execution--and when blue-chip corporations such as GM, AIG and Goldman Sachs were presumed never possibly to default. In spite of the obvious disproof in 2008, investment professionals continue to parrot strategies built on the deceased assumptions of a previous century.
Covered Calls, Put-sells, Put-buys and short-selling are other wooden fire escapes. Covered Calls and Put-sells are often touted as adding to security and profits. However, they limit your investment choices, require constant attention, and worst of all, reduce the effectiveness of Stop orders. Put-buys and any method of short-selling usually cost more than they earn--and if derivative-based are not safe from a 2008-level collapse of major banks sans bailouts. Even if you come out ahead with short-selling, the long term gains will always be much less and the risks much greater than for the same level of expertise applied to long-buying. Why bother?
For the average investor, the most sensible hedge investment is merely to stop investing. Stop orders are the most safe safety feature for equity ETFs, just as brakes are the most safe safety feature for a car. Likewise however, Stops will slow down your average gains and are not foolproof. As we have just seen (July 8, 2015) trading can be halted intentionally or due to a technical glitch. Also, the Stops could fail during a sudden collapse. Also, the account value could be whittled down by repeated false starts. Therefore, even with Stops, the most cautious investors might wish to increase their short-term US Treasury TIPS ETFs (NASDAQ:VTIP) (NYSEARCA:TDTT) (NYSEARCA:STPZ) (NYSEARCA:TIPX) (NYSEARCA:STIP) (NYSEARCA:SIPE) (or TIPS ladder) to 50% of portfolio value.
(In theory, the USA could default. However, in 2008 and other times, it was the federal government that bailed out municipalities and corporations, never vice-versa. If the USA goes down, every government also becomes at-risk--even Swiss currency and Swiss government bonds will not be more than quasi-safe. So, if doubtful about the US government, the only meaningful diversification for TIPS is gold. Please note that close-to-spot gold coins are slightly safer than gold bullion ETFs--and a TIPS ladder is slightly safer than short-term TIPS ETFs if you can hold every rung to maturity. There is also good reason for simply holding some paper US dollars in safety deposit boxes. Consider all of these if you can. However--so long as you avoid applying more than 10% of account to any single gold or TIPS ETF--the ETF method is in some ways more secure. ETFs also provide the only practical method for instantly switching and rebalancing within stock market accounts.)
In summary: unless you either are an aficionado who burns the midnight oil or a multimillionaire with a private manager, it is not very feasible for non-US investments to achieve the level of diversity or security of simply holding three or four broad-based and US-based equity ETFs. Especially so if you want to maintain Stop orders--which, if properly done, requires moderating both the number and the bid-ask spreads of your positions.
However, being "less insecure" does not make US investments secure. In spite of now being apparently in remission, the Greek disquiet still could metastasize such as to destabilize the EU and consequently every stock market investment in the world.
Also, aside from Greece, the EU can worry about its dependence on Russian fuel and whether Putin is restarting the cold war. Not to mention climate change, terrorism, epidemics, etc. Investors worldwide are fortunate that shale oil and new technologies have extended "peak oil" by several decades. However, nobody consequential seems to be suggesting that we ration the new windfall to a sustainable level. Rather than learn from past mistakes, we are assuming that the slash-and-burn attitude of the past has been vindicated and repeating it with greater fervor. Consequently, we are entering an era of potential disasters of Biblical proportions.
On top of it all--unlike in the past half-century--the next severe recession could unfold within a matter of minutes due to high-speed trading. Also unlike in the past half-century: the Chinazone is equally effectual as the US or EU--but less well-regulated--and operates on a 12-hour difference. Therefore--unlike in the past half-century--the next economic tsunami has perhaps a 50-50 chance of being both unexpected and half over before you wake up one morning.
Therefore, I do not wait for scary news before going on Defcon 1. I normally maintain Trailing Stop-sell orders set between -5% and -15% on every equity ETF. (Perhaps tightening for new Stops, then normalizing as gains are made.) In addition, I hold about 25% of account value in short-term US Treasury TIPS ETFs--"guaranteed by the full faith and credit of the US government"--and rarely gaining or losing more than 2% annually in all market conditions. In addition, when the Stops are triggered on my equities, conditional orders will temporarily invest up to 30% of account value in gold bullion. (While not applying more than 10% to 15% of account to any single TIPS or gold ETF.)
In this manner--I quit the stock market automatically in times of danger. In addition, I do not depend entirely on the solvency of my broker or the SIPC to secure the resulting cash balance. Gold can lose value if the stock market rebounds quickly. In my opinion however, that is not so much a risk as a reasonable fee for being more secure--so long as I never apply more than 30% of account to gold. Also, thus far, holding 30% in gold intermittently in this manner has not been costly.
(Of course, investors planning to use Stops with less than $250,000 per account might want to insist on brokers with per-trade fees of $5 or less. Investors with only $500 to $50,000 per account might also loosen the Stops and slash the number of positions proportionally. I intend later to submit detailed do-it-yourself suggestions for publication at Seeking Alpha.)
Disclosure: I am/we are long FPX,GURU,PHDG,SVXY,VBK,XRT, ZIV.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.