Survival Rules For A Zombie Stock Market

by: Eric Parnell, CFA

"Fasten your seat belts. This is going to be a bumpy ride"

-Columbus, Zombieland, 2009

The stock market officially died several years ago. After struggling to stay alive after first contracting financial contagion in the summer of 2007, stocks ultimately declined to their death by early 2009. But then the mystical forces of monetary policy went to work by injecting unprecedented stimulus into the equity corpse. Suddenly the stock market was back to life and it has been seemingly responsive ever since. Today's stock market is no longer truly conscious or functioning normally, however. Instead, it is still beyond dead. It is a zombie stock market.

So how can we truly tell that we're dealing with a zombie infested stock market? Since the death of the stock market several years ago, the economy has unfolded largely as expected. Already excessive debt levels have increased, monetary policy is still extremely easy and largely unaffective, global currencies are being aggressively debased with the euro facing potential extinction, politicians have applied confusing regulations and are mulling tax increases on the wealthy, the flow of global credit is constrained, and overall unevenly sluggish economic growth is now slowing once again.

Amid this deeply challenged economic environment, investors have fled the stock market in droves. Overall, we've seen over $500 billion in net outflows from domestic equity mutual funds since the first outbreak of financial contagion including $300 billion since the market bottom in March 2009. In other words, money continues to leak out of the stock market virtually every week, which reasonably implies that it should still be going down. Yet the stock market has more than doubled from its lows in March 2009 the moment quantitative easing began. This is a market that officially died in March 2009 and was brought back to life as a zombie by monetary stimulus.

So how can investors ensure their survival in a zombie stock market. As the movie Zombieland reminds us, it is critical to keep a set of rules always in mind.

Cardio: This is not an environment for buy-and-hold investors. Those that bought the S&P 500 Index (SPY) thirteen years ago in July 1999 are staring at a price level loss today. Instead, investors must remain nimble and ready to move quickly in a zombie stock market. Otherwise, one runs the risk of getting eaten alive by the next major stock market decline.

Beware of Bathrooms: An illiquid stock position is like a bathroom - it can be difficult to escape once you're trapped inside. Investors are best served to focus on positions, particularly ETFs and large cap stocks, that are highly liquid and can be easily sold at a moments notice if needed.

No Attachments: An investor may have a position that they absolutely love. And all of the fundamental and technical analysis in the world is telling them that the position makes complete sense to hold. It is usually exactly at this moment that the stock market will move in the complete opposite direction and devour the position. Thus, investors are best served in a zombie stock market to stand ready to capture gains and cut losses quickly when necessary.

Travel in a Group: Stocks should not be the primary weapon in an investor's portfolio when battling a zombie stock market. Hedging your portfolio with a broad group of widely diversified asset classes is the best way of increasing your chances of survival. So when the zombies rise to chomp on your stock positions, your allocations to Agency MBS (MBB), U.S. TIPS (TIP), Build America Bonds (BAB) and Long-Term U.S. Treasuries (TLT) helps to make sure your overall portfolio can stay ahead of the danger. Moreover, when the zombies turn their focus instead on the bond market, holding stocks can provide just as much protection, although investors are best served to carry higher quality and more predictable contagion resistant stocks like McDonald's (MCD), Nike (NKE) and Hormel Foods (HRL). And like any crisis scenario, it is always worthwhile to have Gold (GLD) and Silver (SLV) on hand to protect against a variety of outcomes including rapid inflation or a currency collapse.

Kill With Efficiency: If an investor puts on a position to try and time a zombie stock market, they are best to not fill their account with an array of names that look good in a portfolio. Instead, identifying one or two blunt weapons like a highly liquid, broadly diversified stock ETF like the SPDR S&P Mid-Cap 400 (MDY) provides the best way to get in and out of a technical trade and capture short-term upside with efficiency.

Know Your Way Out: When buying any position in a zombie stock market, an investor must know the prices that would trigger a sale and a move to the exits. Not having an escape plan and holding a position too long can prove treacherous.

Don't Be A Hero: A zombie market will constantly present trading opportunities that look too good to be true. Unfortunately, the actions of global policy makers on any given day can quickly prove these investors painfully wrong. Thus, investors are best served to resist piling into any position with aggressive overweights. Instead, smaller, more calculated bets are often the best way to add value on the margins.

Enjoy The Little Things: Although dangerous, the zombie stock market is also filled with opportunities. Thus, the ability to move past losses to identify the next set of potential gains remains critical. This is a challenging environment in which to invest, but it will eventually pass. In the meantime, make the best of it.

Just like any horror movie, the terror of the zombie stock market will eventually end and lead to a happy ending. The extreme volatility and unpredictability of the last several years will someday pass. This will most likely occur once policy makers finally allow the global financial system to fully cleanse itself, which will ultimately lead to the beginning of the next major secular bull market. These will be a welcome development, as the stock market can finally return to normal life and the trials of the zombie stock market will be gone but not forgotten. In the meantime, investors need to continue to stay sharp in working to survive the zombie infested stock market.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.

Disclosure: I am long GLD, SLV, TLT, MCD, NKE, HRL, MBB, BAB, TIP.