If the second half of 2011 was characterised by rampant stock market volatility and looming uncertainty, the atmosphere on Wall Street could be described as the exact opposite thus far in 2012. Economic data releases on the home front have taken centre stage in recent months as better-than-expected results from the labour and housing markets have helped to restore confidence back in the recovery. Underneath the growing euphoria, however, lies an ugly truth; monetary stimulus from the Federal Reserve has been a major driver of equity market appreciation, which could point to troublesome times ahead as the latest quantitative easing program nears an end [see also Doomsday Special: 7 Hard Assets You Can Hold In Your Hand].
Ben Bernanke embarked on the latest round of stimulus back in September of 2011 with the start of “Operation Twist”. This cleverly titled program consists of the Fed buying $400 billion of longer-dated Treasuries and selling ones with remaining maturities of three years or less through June of 2012. The announcement of “Operation Twist” lit a fuse under domestic stocks as investors cheered on the ongoing stimulus efforts by the Fed [see Bond ETFs For Every Objective].
A Predictable Ending To “Operation Twist”?
Although price action has been overwhelmingly positive on Wall Street over the past few months, a look back at history may help to foreshadow some concerning developments. In a recent article at BusinessInsider.com, author Simone Foxman offers an interesting take on a frightening observation regarding stocks and stimulus. The author takes a look at a recent note from Barclays U.S. equities strategists Barry Knapp and Eric Slover; the experts contend that U.S. stocks are due for a pullback as “Operation Twist” comes to an end.
Knapp and Slover believe that a sustainable period of equity market appreciation is unlikely until the Fed begins normalizing policy. What this means is that the ongoing bull-run has been fuelled artificially so to speak, and history reveals that the announcement of stimulus sparks a rally on Wall Street, while the end of a quantitative easing program signals the beginning of a stock market correction [see How To Hedge For A Market Correction With ETFs]. After the first round of quantitative easing, U.S. stocks took a brief nose-dive until QE2 was launched into action. History repeated itself again as stocks tumbled after QE2 came to an end, only to bounce back higher following the most recent announcement of “Operation Twist”.
With “Operation Twist” set to expire by the end of June 2012, many investors are looking ahead to how equity markets will react if no additional stimulus measures are announced this time around. Additional stimulus is a double-edged sword; investors could interpret this is as a pessimistic sign that the economy is still in the gutter, while others may be spooked by resurfacing fears of inflation if the Fed continues to ramp up the printing presses [see also Greedy When Others Are Fearful ETFdb Portfolio].
Below we highlight three ETFs that could perform well if history repeats itself and stocks turn lower as quantitative easing ends:
- FactorShares 2x Gold Bull/S&P 500 Bear (FSG): The premise behind this ETF is quite simple; FSG tracks the difference in daily returns between the price of gold and equities by taking a long position in the precious metal along with a short position in U.S. stocks. This spread ETF could perform well as investors scale back their risk exposure by jumping ship from stocks and into safe havens like gold [see also How To Play A Treasury Bubble With ETFs].
- UBS ETRACS Fisher-Gartman Risk Off ETN (OFF): This fairly new offering allows investors to make a “risk off” bet that spreads across a variety of asset classes through the purchase of a single ticker. OFF consists of short positions in risky assets like international stocks and emerging market currencies along with long positions in “safer” assets such as the Swiss franc and U.S. Treasuries. If a wave of risk aversion strikes, the asset classes in which this product maintains short positions should generally decline in value, while safer assets will get a boost from investors looking to avoid the turmoil.
- QuantShares U.S. Market Anti-Beta Fund (BTAL): This ETF offers investors a creative way to bet on a market correction without taking on risky short positions. BTAL’s underlying index is equal weighted, dollar neutral, and sector neutral consisting of long positions in the lowest beta U.S. stocks coupled with short positions in the highest beta stocks. In essence, BTAL allows investors to profit when uncertainty arises as lower beta securities are likely to outperform “riskier” stocks. This approach may appeal to investors who anticipate an increase in volatility, but wish to avoid taking an outright short position in the market.
Disclosure: No positions at time of writing.
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