The comments last week from Ben Bernanke that calmed the financial markets and sent stocks, bonds, and commodities soaring are leaving no doubt that the Federal Reserve Chairman is the most powerful man in the world. He clearly possesses the ability to move asset prices in any direction that he wishes based on a simple thumbs up or thumbs down to the endless supply of bond purchasing. That much power in the hands of one individual is definitely a dangerous thing and makes me question just how rigged the system is when it comes to managing your portfolio in this day and age.
I think that the last two months have brought into stark detail the amount of devastation that even a hint of tapering will do to the financial markets. We saw bond prices swoon in May and June when there were signs that the Federal Reserve might start backing down their asset purchase programs in 2013. However, that anxiety was tempered when Ben reassured investors that they are on the gas for the foreseeable future.
It’s amazing to me how investors have been conditioned that a bad economy in which the Federal Reserve has to interject itself into the financial markets is a plus for stocks, bonds, and gold. On the flip side, the notion that the economy is improving and intervention from the Federal Reserve will no longer be needed is actually seen as a bad thing for asset prices. The markets inevitably start falling apart at the very hint of such positive news. The term “Goldilocks economy” is still very present in the financial markets – not too hot, not too cold, but just right.
Last week we saw the nearly every asset class follow through with some of the most impressive one-week gains of the year:
Many stocks and major indices hit new all-time highs and it appears that both gold and bonds are starting to stabilize. This is definitely a positive across the board as everyone wants to see continued prosperity and upward trending asset prices. However, I am skeptical about the ultimate outcome from this mess and how the Fed is going to wean investors from this form of life support. When we get so accustomed to having a comforting backstop, the mere thought of it going away can be terrifying.
I am having that same type of problem right now with trying to get my 15-month old son off of a bottle before bedtime. The soothing he receives from that innocuous habit can be a hard one to break. I am often reminded of the phrase – “old habits die hard”.
So now the question is – where do we go from here and how do you position your portfolio for success?
This has been a very difficult market to navigate because trying to pick tops and bottoms can be especially tricky when a Fed press conference can send the markets careening in a different direction. More active day and swing traders love this type of volatility because they can jump in and out of the market at a moment’s notice and capitalize on short-term trends.
For intermediate and long-term investors you have to be more cautious about making drastic changes to your portfolio that will ultimately lead to under performance. My first word of advice is to stick with your investment discipline and try to leave your emotions at the door. By keeping a level head and making unemotional decisions, you will be better equipped to stick with your sell discipline or make opportunistic purchases when the conditions are most favorable.
If you are nervous about a specific asset class such as bonds, you should consider using a bounce to shorten the duration of your portfolio so that you don’t have as much sensitivity to interest rates. Two ETFs to consider are the Vanguard Short Term Bond Fund (BSV) or the PIMCO 0-5 Year High Yield Bond Fund (HYS).
If you are worried about the prospect of falling stock prices, then I would recommend using this strength to sell more highly appreciated positions and move a portion of your portfolio to cash. You can also consider swapping out volatile growth or international positions with low volatility funds such as the iShares MSCI U.S. Minimum Volatility ETF (USMV). Keep in mind, I would prefer to pick up new positions in stock oriented ETFs on at least a modest dip in the market to enhance your chances for success.
Right now it looks like the fire hose of liquidity that the Fed has been using to extinguish the flames of a recession will continue to flow. However, I would not be surprised if we see additional points of volatility in the future that you can use to your advantage. By staying nimble and having a game plan you can come out on the other side of this unique economic situation a winner.
David Fabian is the Chief Operations Officer and Managing Partner of Fabian Capital Management. To get more insights from Fabian Capital visit their blog here or click here to download their latest special report, The Strategic Approach to Income Investing.