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Allocating Assets When The Fed Talks Out Of Both Sides Of Its Mouth

One year ago, each of the 17 members of the Federal Reserve provided an expectation of where the fed funds rate would be at the end of 2015. The average came in at 1.1%. Here in mid-June, the average expectation for committee members for the end of the year now registers 0.45%. If the party is set to rage on, then, shouldn’t investors aggressively allocate dollars in U.S. equities? Not from my vantage point. One year ago, each of the 17 members of the Federal Reserve provided an expectation of where the fed funds rate would be at the end of 2015. The average came in at 1.1%. That might have required four to five rate hikes this year alone. By March, the expected year-end rate dropped to 0.65%. Perhaps two or three rate increases, then? Nope. Here in mid-June, the average expectation for committee members for the end of the year now registers 0.45%. The financial markets have even less conviction about a 2015 increase to the cost of borrowing. Investors via fed funds futures are only pricing in a 22% chance that the Federal Reserve raises the benchmark rate in September and a 62% probability of a rate liftoff at the central bank’s December meeting. Personally, I imagine one face-saving hike this year – a one-n-done to say that they did it. Nevertheless, nobody will be removing much of the alcoholic punch from the the party’s punch bowl anytime soon. Diminished expectations have not been confined to 2015 alone. Fed forecasts for year-end 2016 have dropped from roughly 1.9% to 1.6%. For 2017, they’ve moved down to 2.9% from 3.1%. And that’s not all that the Fed has downgraded. As recently as three months earlier, the institution anticipated 2015 economic growth at 2.3%-2.7%. Yesterday, committee members revealed an assessment of a lethargic 1.8% to 2.0%. Wait a second. Haven’t chairwoman Yellen and her colleagues been prattling on about economic acceleration since last year? Haven’t they been stressing transitory factors to explain every bit of weakness, while simultaneously pointing to improvements wherever they can be emphasized? With one side of its collective mouth, committee members are talking up the economy’s advances. With the other side, it currently believes that the economy will grow even slower than its post-recession growth rate of approximately 2.1%. Keep in mind, our 2.1% post-recession performance is historically weak under normal circumstances. Since 6/2009, though, America received $7.5 trillion in stimulus by the U.S. government; we received $3.75 trillion in electronic dollar equivalents by the Federal Reserve. In other words, unprecedented fireworks only enabled the economy to grow at a lethargic pace. Meanwhile, based on what the Fed members report outside of the media spotlight, they anticipate additional cooling off here in 2015 (circa 1.8%-2.0%). Is it any surprise that stocks would rocket on the probability of fewer anticipated rate hikes alongside a less vibrant economy ? Heck, the Fed successfully talked down the U.S. dollar, kept bond yields from extending their recent tantrum and sent the SPDR Gold Trust ETF (NYSEARCA: GLD ) back above 50-day moving average. If the party is set to rage on, then, shouldn’t investors aggressively allocate dollars in U.S. equities? Not from my vantage point. Successful investors tend to sell complacency, rather than purchase more of it. And “risk-on” investors have become incredibly complacent with respect to sky high valuations as well as Fed accommodation. Understand the real reason that the Fed is even talking about raising short-term rates at all. The monetary policy authorities need to bolster the Fed’s arsenal before the next recession, external shock and/or “black swan” event. They are no longer capable of moving from a 5% fed funds rate range down to 1% or 0%. Instead, we’re now talking about maybe – possibly, someday – getting up to 3% before going back to 0% rate policy and a 4th iteration of quantitative easing (“QE4”). In truth, I doubt that the Fed will ever be able to move beyond 1% before reversing course. Japan has spent the last 15 years stuck at 0.5% or less. That has everything to do with our reliance on zero percent rates and asset purchases with currency credits (“QE”) for six years. Japan made the same error in judgment. Admittedly, the Fed has been marvelously successful at persuading businesses to buy back their stock shares; they’ve convinced pensions, money managers, mutual funds and real estate investors to stay engaged, enhancing the “wealth effect” for the wealthiest among us. (Yes, that includes me.) On the other hand, I have seen the same excesses throughout the decades. I witnessed firsthand what happened to Taiwanese equities in 1986 when Taiwan R.O.C. opened its doors to outside investors. The irrationally exuberant run-up met its panicky demise the following year. I warned investors to have an exit approach to the insanity of dot-com euphoria in the late 1990s; I offered the same warnings leading up to the 2007-2009 financial collapse. In essence, you do not have to be sitting 100% in cash. We still remain invested in core positions such as the Vanguard Mid-Cap Value ETF (NYSEARCA: VOE ), the iShares S&P 100 ETF (NYSEARCA: OEF ) and the Vanguard High Dividend Yield ETF (NYSEARCA: VYM ). Yet we have also raised 10%-25% cash in our portfolios (depending on client risk tolerance) as stop-limit loss orders have hit on both bond and stock positions. We let go of energy investments that did not pan out. We stopped out of longer-term bonds earlier this year. And Germany via the iShares Currency Hedged MSCI Germany ETF (NYSEARCA: HEWG ) is no longer in the mix of any client. The result? More cash for future buying opportunities. And that buying opportunity is likely to be far more consequential than a 3% pullback. With only a few exceptions, we believe it is far more sensible to wait for the real deal – a 10%-plus correction and/or a 20%-plus bear. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, 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 at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.

Inside The Germany ETF Sell-Off

Germany ETFs had a stellar start to this year but failed to hold on to those gains. The key German gauge DAX index entered the correction phase starting this week and retreated over 10% from April. This led the European stocks to log their most stretched-out spell of sell-offs this year, per Bloomberg . In any case, corrections in German equities were in arrears after a prolonged bull run due to the launch of the QE measure by the ECB. Even after the steep sell-off, the Deutsche X-trackers MSCI Germany Hedged Equity ETF (NYSEARCA: DBGR ) , the best performer in the Germany equities ETF space from a year-to-date look, returned over 11.5%. Also, the nagging Greek debt deal also brought trouble for the German assets. Wobbly investors are now focusing more on profit booking before anything worse happens to the fate of the common currency Euro. Though such chances are low, little progress in the Monday meeting over Greece’s bailout program sent shockwaves to investors. Greece has held up its debt payments of 303.3 million euros to the International Monetary Fund (NYSE: IMF ), which was due on June 5. Instead, the IMF chief spokesman said that Greece plans “to bundle the country’s four June payments into one, which is now due on June 30.” In the meantime, Greece’s creditors have proposed for stricter austerities like pension cuts, tax increases and other policies (which need to be put into practice by Athens) in return for a bailout program until the end of March 2016. A conflict between Athens and its creditors will find a compulsory retreat of Greece from the Euro zone which in turn will see other Euro zone countries from Malta to Greece’s biggest creditor – Germany – in dire straits. Among the major losers, DBGR, the iShares Currency Hedged MSCI Germany ETF (NYSEARCA: HEWG ) , the WisdomTree Germany Hedged Equity ETF (NASDAQ: DXGE ) and the iShares MSCI Germany Small Cap Index ETF (BATS: EWGS ) deserve special mention. While DBGR lost the maximum by 3.50%, HEWG was off 3.49%, DXGE lost 3.36% and EWGS retreated 2.76% in the last one week (as of June 9, 2015). The situation was no different in the German fixed income market either. The yield on 10-year German government bonds rose to 1%, which is almost a nine-month high. Investors should note that the same bond yields were almost zero percent only a few days back. Reduced fears of deflation in the Euro zone might have led the bondholders to ask for higher yields. Notably, the Euro zone recorded a six-month high inflation in May at 0.3% . So, a spike in yield is somewhat self explanatory. This, along with Greek worries led to the anxiety in the market. Over the last five trading sessions (as of June 9, 2015), the PowerShares DB German Bund Futures ETN (NYSEARCA: BUNL ) lost 3.2% and is down over 4.6% year to date. Link to the original post on Zacks.com

U.S. Stocks And U.S. Bonds: What The Heck?

It is hard to believe just how many folks expect the U.S. stock market to rise substantially in the current environment. U.S. stocks and U.S. bonds are extremely overvalued. As long as one has a plan for exiting – rather than foolishly hoping-n-holding – one is able to minimize the risk of remaining invested in overvalued equities. Most people believe that Tom Cruise became an international superstar with the release of the action drama, “Top Gun” back in 1986. However, I remember the actor from an earlier film, “Risky Business.” The popular motion picture capitalized on teenage angst and harebrained ways to make money. In the film itself, the main character, Joel Goodson, turns his family home into a house of ill-repute to finance the repairs of his father’s Porsche – a car that he had been warned not to use, yet inadvertently destroyed. By the end of the movie, increasingly perilous behavior helped Joel get into Princeton, as opposed to him following a straighter-and-narrower path. Fans may recall the risk-taking tagline, “Sometimes you just gotta say, ‘What the Heck.'” In Hollywood, at least for the sake of on-screen comedy, irrational audacity may prove rewarding. In real life, however, investors tend to be compensated for taking reasonable risks. Granted, speculators can sometimes profit from bizarre decisions. Yet an investor who allows over-the-top exuberance to cloud sound judgment typically gets battered by panicky reversals of fortune. Indeed, it is hard to believe just how many folks expect the U.S. stock market to rise substantially in the current environment. Companies are not selling as much as they had anticipated as shown by rising manufacturer, wholesaler and retailer inventories. Companies in the S&P 500 are not profiting as much as executives had hoped either; analysts have been dramatically ratcheting down earnings expectations. Meanwhile, the parade of weak economic reports continue to flow in, from producer prices (excluding food and energy) registering an unexpected decline to smaller-than-expected gains in industrial production. Downward revisions to gross domestic product are a near certainty. What are the implications for the investing public? Sadly, it is a world where the two primary asset classes stateside – U.S. stocks and U.S. bonds – are extremely overvalued. And yet, the choices of how to manage the overvaluation in one’s portfolio are not particularly attractive either. Since there are no meaningful risk-free rates of return in a zero percent interest rate environment, investors have been choosing between risky and riskier alternatives. In one corner, expensive U.S. stocks may continue to appreciate on additional corporate buybacks as well as the possibility of economic acceleration. In the other corner, appallingly low-yielding U.S. bonds may produce total returns that exceed stocks due to the former’s relative value against developed world bonds; most of the developed world’s fixed-income yields are noticeably lower than comparable U.S. maturities. Of the two alternatives, I am still favoring long-term U.S. treasuries in client portfolios. The German 30-year bund yield is under 1%, while the Japanese 30-year is near 1.5%. As silly as those yields are, they are not likely to rise appreciably when the Bank of Japan (BOJ) and the European Central Bank (ECB) are in early stages of bond buying via quantitative easing exercises. Even more alarming? The 30-year yields for France, Canada and Italy are 1.45%, 2.12% and 2.61% respectively. We’re talking about fiscally irresponsible Italy having a lower yield than the U.S. at 2.71%. Does it not make sense to consider long-term U.S. bond exposure via the Vanguard Extended Duration Treasury ETF (NYSEARCA: EDV ) or the PIMCO 25+ Year Zero Coupon U.S. Treasury Index ETF (NYSEARCA: ZROZ ), especially when the 30-year yield has reverted back to a 50-day moving averages? Buying bond dips can be as rewarding as buying stock dips. The increasingly unattractive prospect of robust exposure to U.S. stocks has not kept me from sticking with the trends. My clients will continue to own funds like the iShares S&P 100 ETF (NYSEARCA: OEF ), the Health Care Select Sect SPDR ETF (NYSEARCA: XLV ), the Vanguard Mega Cap Growth ETF (NYSEARCA: MGK ) as well as the iShares MSCI USA Minimum Volatility ETF (NYSEARCA: USMV ) until there is a significant breach of the 200-day moving average on the downside. What-the-heck pricey? You bet. On the other hand, the market can remain insanely effervescent for a whole lot longer than an investor can accept 0% in a money market. As long as one has a plan for exiting – rather than foolishly hoping-n-holding – one is able to minimize the risk of remaining invested in overvalued equities. It is important to recognize, though, that stock uptrends in foreign markets come with lower P/E price-tags. Conservatively speaking, developed world stock assets trade at a 10%-15% P/E discount to the U.S., while broad-based emerging market stock assets may be trading at a 20% to 25% discount. It has been more difficult for me to embrace either the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) or the Vanguard FTSE Emerging Markets ETF (NYSEARCA: VWO ) yet, as both have resistance at their respective 200-day trendlines and both do not have the currency-hedged exposure that I prefer at this moment. In contrast, I have advocated for several months on behalf of the iShares Currency Hedged MSCI Germany ETF (NYSEARCA: HEWG ) on the expectation that as the most successful exporter in the region, Germany will benefit the most from the battered euro. What’s more, HEWG’s uptrend is intact. Disclosure: Gary Gordon, MS, CFP is the president of Pacific Park Financial, Inc., a Registered Investment Adviser with the SEC. Gary Gordon, 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 at the ETF Expert web site. ETF Expert content is created independently of any advertising relationships.