If an economic data point came in much weaker than expected last year, the U.S. Federal Reserve’s monetary stimulus offered reason enough to buy stocks. Bad news served as good news. At the same time, when a data point exceeded expectations, the resilience of the American economy also inspired equity purchases. Good news served as good news.
In fact, any news prompted additional risk taking in 2013. Flat corporate revenue? It will improve. Fed exit from quantitative easing (QE)? They are reducing their bond acquisitions because they see a strong economic expansion ahead.
Here in 2014, we’re seeing a near perfect reversal in market reaction; that is, bad news is being treated with venomous selling, while good news is being treated as an opportunity to get out at a higher price point. Granted, there have been flashes of buy-the-dip block orders from the institutional crowd. For the most part, however, a large percentage of folks are selling first and choosing to evaluate the prospects of the bull market later.
There are a variety of ways to deal with the current corrective activity. Conventional wisdom might suggest that you simply stick with your original asset allocation and ignore the increasingly volatile environment. Easier said than done, and not necessarily shrewd. I prefer an approach where one is insuring against a correction turning into something far more odious. In other words, I’d rather pay a small premium to protect against the possibility of a calamitous outcome, whether or not the calamity comes to fruition.
Here are three ways that investors in ETFs can lessen the impact of a severe down market shock: