Monthly Archives: February 2016

Why You Should Already Be Investing in the MASH Index

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For nearly a decade, the US Federal Reserve (the “Fed”) kept overnight lending rates near zero percent. The reason? Policy leaders wanted to inspire a wealth effect in stocks and real estate. Since deviating from its extremely accommodative course, however, the Fed is now entering rough, uncharted waters.

Whereas central banks all around the globe are still devoted to extreme accommodation through exceptionally low borrowing rates, the Fed stepped in the opposite direction back on December 16th. What did they do? They raised the overnight lending rate by a quarter of a point (0.25%). Since then, large-cap stocks (S&P 500) have corrected by 11%. Likewise, mid-cap stocks (S&P 400) are down roughly 13% and small-cap stocks (Russell 2000) have fallen by more than 16%.

Even those investors who married themselves to beloved “FANG” stocks (Facebook, Amazon, Netflix & Google) are finding it difficult to navigate the volatile seas. In fact, FANG stocks have collectively fallen more than the market at large. These are the companies whose share prices have defied gravity. These are the corporations whose lofty valuations weren’t supposed to matter.

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Ironically enough, FANG stocks have managed to fall an average of 21%. That’s technically a bear market for the popular quartet!

So are fundamental valuations finally coming back into vogue? Absolutely. They always do.

It happened to investors who explained away the tech bubble prices as the “New Economy” norm back in 2000. It also happened to those investors who dismissed the ridiculously high property prices leading into 2007. The pendulum always loses momentum before swinging in the opposite direction. Tragically, investors often find themselves relearning lessons in physics via their investment portfolio.

The justification for extremely high valuations over the past couple of years has always been explained away with zero percent interest rates. If I had a tax-free nickel for every time I heard an analyst, pundit or casual couch investor use the zero percent interest rate excuse to dismiss high price-to-earnings (P/E) ratios, I would use the hundreds of millions in tax-free wealth to acquire a small tropical island. Instead, here I am… writing articles to say, “Get your head out of that dark hole and invest in the MASH Index.”

Here is the key conundrum for investors: Even if the Fed controls the shortest end of the yield curve, what happens when those T-bills, certificate of deposits (CDs), and savings accounts begin paying a little more than just the measly bread crumbs we’ve grown so accustomed to? Won’t that entice investors to move out of those riskier stock assets that they felt compelled to buy before, especially if there is increased volatility and uncertainty in stock markets themselves?

Perhaps you still find yourself in the “it’s just a quarter of a point” camp. Fair enough. But one cannot ignore the super-sized increase in volatility since the December 16th Fed meeting, as well as the failed rallies since the Fed’s last QE3 bond purchase back in late 2014. Insignificant or not, policy direction matters to currencies, commodities, debt instruments and equities, even when the shift itself seems miniscule.

Additionally, one cannot dismiss the dramatic rebound in stocks since 2009 without giving central bank policy changes a big-time tip of the cap. The correlation between central bank intervention and stock market rallies have been rather dramatic. And just in case your memory is not what it used to be, here’s a review of that correlation.

January 2009 to April 2010

The start of 2009 also marked the start of the zero interest-rate policy (ZIRP) era. In a bid to rescue an economy trapped in a death spiral, the Fed took its overnight lending rate from 5.25% in June of 2006 down to the “zero bound” by December of 2008. Yet, those 10 consecutive rate cuts that ushered in the ZIRP era still weren’t enough to curtail the wealth destruction brought on by the collapse in real estate and the subprime catastrophe.

At the tail end of 2008, the Fed announced that it was calling in the cavalry. With rates already at zero percent, the central bank introduced a form of stimulus known as quantitative easing (QE). QE is simply the Fed opening up its wallet, which is filled with electronic dollar credits. (Note: That’s a fancy way of saying that they created money out of thin air to buy bonds so that interest rates would move dramatically lower.) As a result, the Fed’s balance sheet tripled in size. Nearly $1.5 trillion of US Treasuries and mortgage-backed securities were acquired and interest rates did indeed drop. The S&P 500 responded by rallying 80% off of March 2009 lows through April of 2010.

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May 2010 to August 2010

Unfortunately, Wall Street quickly sniffed out the Fed’s goal to bring QE1 to an end. The S&P 500 responded with a 13% drop into June and remained range bound through the end of August.

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September 2010 to October 2010

Still not satisfied at the pace in which the economy was improving, the Fed announced that it would resume QE1. With a newly revised goal to increase its balance sheet to $2 trillion, the Fed began buying even more US Treasuries at roughly a $30 billion per month clip.

The S&P 500 responded with a 17% rally through the end of October.

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November 2010

However, with the end of QE1, the rally began to stall out in November.

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December 2010 to April 2011

Still not satisfied with the pace of recovery, the Fed then announced a second round of quantitative easing (QE2). A total of $600 billion in US Treasuries would be added to the Fed’s balance sheet by the end of June 2011. The stock market received a new head of steam. The S&P 500 rallied 16% through the end of April.

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May 2011 to September 2011

After a few failed attempts at recapturing the April highs, the S&P 500 faced the unknowns of a fast approaching end to QE2. Unfortunately, that would amount to just one of the threats investors faced. A second, even larger, wave of trouble was rolling in from across the Atlantic.

The word “contagion” should refresh your memory of that particular period known as the Eurozone Crisis. The fear of the European Union (EU) allowing Greece to default on its debt obligations, resulting in its ultimate exit from the EU, led many to speculate that there would be even bigger European countries to follow. After all, the balance sheets of Spain, Portugal and Italy were not much better than Greece’s.

The fear of contagion netted the S&P 500 a 19.9% drop from the April highs.

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October 2011 to March 2012

In September, the Fed announced “Operation Twist.” Also known as QE2.5, Operation Twist was simply a way for the Fed to continue acquiring Treasury bonds without opening up its wallet. Quite simply, the Fed sold the short-term Treasury bonds it already owned and rotated the proceeds into new long-term Treasury bonds.

Likewise, the Eurozone Crisis fears began to feed even more central bank stimulus from across the pond. In October 2011, the Bank of England announced that it would undertake more QE, adding £75 billion to its balance sheet. Additional Bank of England stimulus came in February of 2012 as well. The S&P 500 rallied another 24%.

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April 2012 to May 2012

Deals between the EU and Greece continued to go back and forth with no resolve. No real tangible solution, in which all parties agreed, seemed to be within sight. Renewed fears of a Greek exit (or “Grexit”) from the EU flared up once again. In fact, in May of 2012, the National Bank of Greece warned that an exit from the EU was a very real possibility. The market lost its legs once again.

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June 2012 to August 2012

Leading into June, considerable fears surrounded the future of the EU and the fate of the euro should Greece default on its debt obligations. However, Mario Draghi, President of the European Central Bank (ECB), swooped in to save the day. He made a public pledge to do “whatever it takes” to rescue Greece and preserve the euro. The S&P 500 turned higher yet again.

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September 2012 to November 2012

Even with a Eurozone Crisis subsiding, the market rally was short lived. Stocks waffled once again. Not only had the GDP growth rate not yet captured its pre-recession levels, it began to fall.

Still not satisfied with the economic (and jobs, stock, real estate, etc.) recovery, the Fed announced a new stimulus program in September. QE3, or “QE-Infinity” as it became more affectionately known, was an open-ended asset purchase program in which the Fed purchased Treasury bonds and mortgage-backed securities at a rate of $40 billion per month.

The markets failed to respond. The stimulus was viewed as not being a big enough commitment. In fact, the S&P 500 dropped by roughly 8% from the point the Fed announced QE3.

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December 2012 to September 2014

Not satisfied with the market’s response to QE3, the Fed announced a “shock & awe” increase to its QE3 stimulus program in December. It would more than double its monthly asset purchases from $40 billion to $85 billion.

The markets rocketed to new all-time highs. The S&P 500 climbed nearly 44% without as much as a hiccup.

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October 2014 to Current

The Fed announced the retirement of QE3 at the end of October 2014 and finished its last asset purchase in mid-December of 2014. After accumulating roughly $4.5 trillion in assets since it began its emergency-level stimulus programs nearly six years prior, the Fed finally reached the point at which it felt the economy could stand on its own two feet. Or could it?

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As the chart above shows, the equity markets have yet to prove that a meaningful rally can exist without an extremely accommodative Fed. That hypothesis is further supported by the direction the markets have headed since the December 16th rate hike.

And therein lies a second critical conundrum for investors. Are we dealing with an equity market that is coming to terms with a less accommodative Fed? Since all previous rallies following the Great Recession have come on the heels of some sort of central bank intervention, can we have a stock market rally despite a Fed that has become stingier?

If not, what is working in this current environment? The MASH index is working. It is working quite well, in fact.

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As the chart above delineates, the MASH index is outperforming the S&P 500 by more than 17% since the December 16th Fed meeting. Where the S&P 500 is down 11%, the MASH index is up 6%.

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If you’d like to discuss hedging your portfolio against stock risk, please give us a call at (888) 500-4279. Likewise, if you are interested in learning more about the FTSE Custom Multi-Asset Stock Hedge (MASH) Index and whether it is appropriate for your portfolio, please click here to send us your contact information.

 

Disclosure Statement: Pacific Park Financial, Inc. is a Registered Investment Adviser with the SEC. Pacific Park Financial, Inc. and/or its clients may hold positions in the ETFs, mutual funds, and/or any investment asset mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell or hold securities. At times, issuers of exchange-traded products compensate Pacific Park Financial, Inc. or its subsidiaries for advertising on this website. StockHedgeIndex.com is created independently of any advertising relationship.