Stocks have been on quite the jaunt since hitting the nefarious 13-year intra-day low of S&P 500 666 on March 9, 2007 – closing that day at 676. But by the following session everything turned as the AICPA offered more clarity on mark-to-market requirements within the banking system (specifically FASB 157) – the rolling bear raid that decimated financial shares was stopped in its tracks. Of course, one can’t leave out that it was just a couple of months prior in which Bernanke & Co. signaled the first leg of quantitative easing was set to roll. Undoubtedly, the Fed’s actions to push as many people as possible into riskier assets by making the yield on safer assets terribly unattractive has played a major role in the bounce from the bottom and a huge role in this latest leg of the rally.
During those dark days of early 2009, well before it became consensus, our firm made the decision to over-weight the industrial (with a bias to commodity/emerging market-related shares), tech and energy sectors as a combination of the Fed’s money-pumping escapade and that roughly trillion-dollar stimulus package that would involve $400 billion in infrastructure projects (both policies of which I completely disagree with but you’ve got to manage around what the polticos give you). While consumer discretionary and financials (two areas I have avoided simply because the potential return wasn’t commensurate to the risk in my view) have led the market for most of this cyclical bull market, industrials, tech and energy have been good places to be.
Now though one must consider protecting the portfolio, as I believe it’s obvious that this rally is taking place within a secular bear market, by rotating to the traditional areas of safety: utilities, consumer staples and to a lesser extent health care. The time to accumulate is when few are interested. If one is not going to take advantage of the cheap put protection that’s been delivered by an obscene level of complacency, then moving into the these traditional areas of safety should offer downside protection on a relative basis – leaving one more resources with which to deploy into more cyclical areas again once the correction hits. And the utility and consumer staple sectors offer very nice dividend yields if one must park in these areas for a prolonged period because the move lower turns out to be more than a quick correction. That is, the economy slumps again in the back-half of the year and interest rates tumble toward their 2010 lows.
To be sure, there are many potential shocks out there just waiting to jump out and scare the hell out of an overly-complacent market. To quickly name a few: Emerging-market policymakers unsuccessfully implement a soft landing as they seek to quash soaring property and food price, the next round of the eurozone’s debt crisis rolls with a vengeance, our own state and local financial troubles become even more evident as the federal government’s lifeline expires later this year, the next round of home price declines and what that means for banks that have been releasing huge swaths of loss provisions, continued household de-leveraging, corporate earnings that will meet much tougher comparison in a couple of quarters and a Fed that will have quite the decision to make shortly as we move closer to that supposed end of QE on June 30. And of course there’s also the high historical risk of adverse geopolitical events, but I’ll leave that and the positions one should be thinking about for another post.
Now, I must admit that my fair value for the S&P 500 has been in the 900-950 range for 18 months now; instead the market carries on. One never knows how far and long stocks can run, particularly when they’re being juiced by monetary policy like never before. Regardless, the places that have provided the market its juice will quickly wilt when the correction arrives. And I believe the chances of a swift and deep move are very high right now, there are a lot of people ready to head for the proverbial exit door. This is where the safety areas come in and you can keep it simply if you’d like by going the ETF route: XLU and XLP – offering dividend yields of 4.65% and 3.49%, respectively, as of this writing.