September 27, 2013 – For Stock Investors, It’s Time to Take Chips Off the Table: What goes unspoken can be more important that what is spoken. That was perhaps the biggest lesson of the past few months when Fed Chairman Ben Bernanke and his colleagues implied they’d like to reduce the central bank’s purchases of bonds. Left unsaid: If the markets moved too far ahead of the Fed, all bets would be off.
The bets were canceled last week when Bernanke & Co. shocked the markets by maintaining the status quo at their Federal Open Market Committee meeting. Looking back, perhaps it shouldn’t have come as a surprise. Stocks and bonds had moved sharply from May to late August in anticipation of tapering (see chart).
In roughly three months, the 10-year Treasury yield had almost doubled to 3%, while the S&P Homebuilding Index had slid by a third. “I don’t think [Bernanke] wanted to see rates rise to a level where they would impact economic activity,” says John Manley, chief equity strategist at Wells Fargo Advantage funds. Bernanke, a student of the Depression, would rather be three months too late than one month too early.
International markets had been on the move this summer as well. The Market Vectors Indonesia Index exchange-traded fund (ticker: IDX) lost 38% and the price of Brazil’s 10-year bond fell 13% from May to late August, notes Lawrence McDonald, senior director, U.S. credit, equity and policy strategist at futures broker Newedge USA. “I think the Fed was worried about the losses in the emerging markets,” says McDonald, who created the Lehman Systemic Risk Indicators Index.
A portion of those large losses reversed over the past month. The 10-year Treasury yield has fallen back to 2.7% and the homebuilding index is up 13% since Sept. 5. The ETF of Indonesia’s stocks rose 6.5% last week and almost 25% from its August lows. Likewise, Brazil’s 10-year note gained 3% last week and is 6.4% above its lows.
What now seems clear is that it’s going to be a lot harder than most thought for the Fed to remove its stimulus without seeing some major side effects — and not good ones — in the markets. So, given stocks’ amazing gains in recent years, it may be time to start taking chips off the table. This bull market is 54 months old, downright ancient compared with the average bull, which lasts 39 months, notes Frank Gretz, a technical analyst at Wellington Shields.
To double-check our conclusions, we rang up Charles Gave, chairman of GaveKal, a staunch bull since we first interviewed him in September 2011. Back then, the stock market had suffered a sharp pullback on fears that Greece would require a debt restructuring. Yet Gave was a table-pounding optimist because he saw the event as a wake-up call to nations to deleverage. He grew even more bullish as interest rates fell below the inflation rate, arguing that stocks were the only alternative for anyone seeking real returns.
Investors who heeded his call were rewarded: Since September 2011, the S&P 500 has rallied 50%.
But this summer, Gave pulled in his horns. Once interest rates rose and investors could again reap a positive real return in long-dated debt, he suggested they put 50% of their money in 30-year, zero-coupon U.S. government bonds and the rest in equities. Doing so will protect a portfolio from a black-swan event, he argues. With stocks hitting all-time highs last week, a little insurance seems like a good idea.
It’s now clear that any tapering by the Fed will pummel the stock market. Management and big investors are selling big chunks of their positions. Follow the “smart” money and cut stock positions. Do not let your stock portfolio turn into a disaster. (Credits – By Jacqueline Doherty for Barron’s Magazine).
The Master of Disaster