What If Stocks Decline?

Successful investors are the ones that are always making plans for all sorts of contingencies, so it stands to reason that they should even prepare themselves for the possibility of stocks actually declining one of these days...

I was thinking about the coming correction in stocks and how to position my portfolio for that moment when equities once again feel the effects of gravity when I stumbled upon an interesting tool at ETFreplay.com that they call their Down Day Association Stats. In a nutshell, it looks at the performance of a group of user-specified exchange-traded products on those days in which a benchmark falls X%.

In the example below, I have chosen SPY as my benchmark, 2% (per day) as my threshold decline and 36 months as my lookback period. I looked at 25 ETPs that cover a wide range of asset classes and investment approaches.

Some of the results from the Down Day Association Stats are not particularly surprising. For instance, the long bond (TLT) and the dollar (UUP) have a strong negative correlation to stocks and generally perform well when SPY declines sharply. Some of the other bond choices (LQD, PCY, BWX) have been better at treading water than countertrending, but also show the benefits of diversification. The commodity choices were somewhat disappointing, generally managing to lose at best half as much as SPY, with crude oil almost matching the declines in the SPY to the penny.

Among the data points that surprised me were that the frontier ETF (FRN) fared better than the SPY in big down days, while real estate (IYR) fared worse.

Of course every decline in stocks has a different set of catalysts and puts different stresses on different asset classes, sectors and geographies, but as stocks continue to grind higher, be sure to make preparations for that eventual pullback, because when it finally does arrive, it will likely do so at an inconvenient time and with surprising swiftness.

Related posts:

• A VIX Risk Reversal
• Performance of Volatility-Hedged ETPs
• Comparing SPLV and VQT
• Performance of VIX ETP Hedges in Current Selloff
• Dynamic VIX ETPS as Long-Term Hedges
• Three New Risk Control ETFs from Direxion
• Frontier ETFs
• Some Favorite ETF Sites
• ETFreplay.com Brings ETFs Volatility and Charts Together Under One Roof

[source(s): ETFreplay.com]

Disclosure(s): long LQD at time of writing

Emerging Markets Bond ETFs Soar

While there have been pockets of strength in emerging markets for equities (see links below), emerging markets bonds have been even stronger performers in 2010, both on an absolute and risk-adjusted basis. In fact, if one compares the chart of emerging markets bonds below, the gap between emerging markets and developed markets looks strikingly similar to what was seen on the equity side in Chart of the Week: Rethinking Geography.

I first wrote about PCY (the PowerShares Emerging Markets Sovereign Debt Portfolio ETF) back in October 2008 in the context of an indicator of the strength of the global economic in general and emerging markets in particular. Since that time, PCY has been an extremely strong performer, gaining 35.6% in 2009 and adding another 13.0% so far in 2010. Along the way, PCY has attracted completion in the form of EMB, the iShares USD Emerging Market Bond ETF, which was up 15.4% in 2009 and is up 11.5% year-to-date in 2010. Of course both PCY and EMB have been able to post these excellent returns with only a fraction of the risk of their equity market counterparts.

For comparison sake, I have also included two international bond ETFs that have a much higher weighting in developed markets than emerging markets. Of these two the more liquid is SPDR Barclays Capital International Treasury Bond ETF (BWX); the S&P/Citigroup International Treasury Bond ETF (IGOV) is a relative newcomer. A shorter duration option in this space is the S&P/Citigroup 1-3 Year International Treasury Bond ETF (ISHG).

It may be a global marketplace, but geography continues to have a strong influence over local and regional risk and reward. Without the sovereign debt problems, zombie banks and housing bubbles, emerging market debt is an attractive place to diversify a portfolio and capture a relatively high yield, such as the 5% or so currently available from PCY.

Related posts:

• Watch Emerging Market Bonds
• Chart of the Week: Rethinking Geography
• More Top Emerging Market ETFs
• Chart of the Week: Irrepressible Colombia (GXG)
• Frontier ETFs

[source:ETFreplay.com]

Disclosure(s): long PCY at time of writing