We Are All Alone

by John Nyaradi, Wall Street Sector Selector

Investors are on their own and cannot count on the Federal Reserve to save their portfolios.

Global markets seem to be pricing in a new round of quantitative easing from the Federal Reserve.  Dr. Bernanke and his colleagues will likely comply sometime between now and December.  However, even with more quantitative easing, investors can’t count on the Federal Reserve to rescue the stock market and their portfolios.  We are on our own, and here’s why:

1. Europe’s Debt Crisis

Europe is the crisis that just won’t quit, with Spain, Italy, Greece, ad nauseam , all running out of money. There is simply no solution to this problem as there is simply not enough money in Europe to save Italy and Spain. When the piper finally demands to be paid, no central bank on earth will have the firepower to stop the global financial avalanche that this crisis could trigger.

2. Earnings

Second-quarter earnings season is shaping up as a weak affair with downgrades coming from most every sector. As we all know, stock prices eventually are based on earnings, and no amount of monetary policy, low interest rates or quantitative easing can add profits to corporate bottom lines. Monetary policy can set the stage for, but cannot create, demand.

3. Global Recession

This item is part and parcel of Items #1 and #2. Recession is quickly spreading across Europe. China’s economy, while still growing briskly by developed world standards, is rapidly slowing. The United States limps along with a 1.9% growth rate and recent GDP estimates have been sharply revised downwards. Like antibiotics for a sick person, Dr. Bernanke and his Fed can help but the disease must run its course and the patient must have the physical strength to survive on his own.

4. Diminishing Returns of Quantitative Easing

Each round of quantitative easing has smaller impact and brings greater risks for the global economy. Last week’s interest rate cuts by the European Central Bank, the People’s Bank of China and more quantitative easing from the Bank of England were largely ignored by global markets which, in the “good old days,” would have rallied hard on this sort of same-day global intervention.  Like antibiotics fighting a virus, quantitative easing is losing its effect as the virus grows immune and mutates to offset continued attacks.

5. The Dreaded Fiscal Cliff

Dr. Bernanke has made it quite clear in recent testimony to Congress that the “fiscal cliff” coming up in December is too big for him to manage and that it needs to be resolved to avoid a significant economic shock. The hit to GDP from the fiscal cliff would likely trigger another recession in the United States (See Item #3)

ETF strategies for difficult days

So what are we supposed to do as we try to protect capital, prepare for retirement and secure our financial futures? Several options come to mind:

A. Cash: Cash is king, particularly in deflationary, depression-like environments. The U.S. dollar, represented by PowerShares DB Bullish Dollar ETF (NYSEARCA:UUP) is up some 5% since early May as capital seeks the perceived safety of the U.S. dollar. Cash doesn’t have to be U.S. dollars, either, as Swiss francs have been on a roll, along with the Japanese yen (NYSEARCA:FXY)

B. U.S. Treasury Bonds: Like the dollar, the U.S. is still seen as the safest harbor in an uncertain world and U.S. Treasuries are near record low yields and high prices as money flocks to the perceived safety of Uncle Sam. The biggest moves will probably come in the long end of the curve and iShares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT) is up some 14% since early April. iShares Barclays 7-10 Year ETF (NYSEARCA:IEF) has gained more than 5% in the same time frame. One day, the “short” bond trade will be the position of a lifetime, but that day does not look like today.

So now it’s summertime, but the living is not likely to be easy, at least for awhile. (apologies to George and Ira Gershwin, “Porgy and Bess”)   We can’t count on Dr. Bernanke and his Federal Reserve to save us from what lies ahead but we can use the power and versatility of exchange traded funds to navigate through these challenging times.  We are all alone.

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Disclosure: Wall Street Sector Selector actively trades a wide range of exchange traded funds and positions can change at any time. Wall Street Sector Selector holds a position in (TLT)

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