Matt McCall isn’t as worried as lot of other people that the
If you listen to the talking heads in the financial media, the odds of a double-dip recession are increasing by the minute. And if you hit the streets and ask the average investor, the odds increase even more.
That said, I felt it was only prudent to share my Double-Dip ETF Portfolio (DDP) that can help protect your portfolio in the event that the masses are correct.
But before I discuss the 10 ETFs in the DDP, I’d like to share my thoughts on the possibility of a double-dip recession. Contrary to the majority of investors and advisers, I feel the possibility of a double dip is quite low.
When the recession began in late 2007, the economy and stock market were at different stages than they are now. There’s also the fact that corporate profits are growing—granted at a slow-to-moderate pace, but they are growing even as consumers sit on their cash.
I also tend to take a contrarian view of the situation, and when the majority of investors are calling for a double dip, the likelihood of it actually occurring is minute. There are several other key factors behind my thought process, but that’s a story for a different article.
As I said, the DDP is composed of 10 ETFs with equal weighting (10 percent each), and the dividends are paid into the cash account.
ProShares Short S&P 500 ETF (NYSEArca: SH) seeks to return the daily inverse of the S&P 500 Index. For example, if the S&P 500 gains 1 percent on the day, ideally SH will lose 1 percent and vice versa. This ETF gives the DDP direct exposure to a falling stock market, helping investors benefit from lower prices.
Rydex CurrencyShares Japanese Yen ETF (NYSEArca: FXY) is designed to track the price of the Japanese yen. During recessions and bear markets in stocks, the yen has recently been the safe-haven currency. In 2008 when nearly every asset class was falling, FXY gained 22 percent and was one of the best investment options in the entire investment world. Regardless of the Bank of Japan’s efforts to curb the climb in the yen, if a double dip occurs,
Vanguard Intermediate-Term Bond ETF (NYSEArca: BIV) invests in bonds with maturities between five and 10 years with just over half backed by the
Market Vectors Double Short Euro ETN (NYSEArca: DRR) offers investors double the inverse of the euro versus the U.S. dollar on a daily basis. If the euro falls 1 percent versus the dollar, DRR will gain 2 percent and vice versa. DRR is the only leveraged product in the portfolio because over time the volatility will hurt the overall return. With the lack of a short euro ETF available, the next best was a leveraged short euro product. If the
SPDR Gold ETF (NYSEArca: GLD) has one objective, and that is to track the price of gold bullion, less the trust’s expenses. Over the years, during times of uncertainty gold has been an asset that investors flock to for safety. Add in the fact the metal is near an all-time high, there’s a small fear of inflation, and now the metal is considered a currency hedge. I think the probability of higher prices is good.
Market Vectors High-Yield Municipal Bond ETF (NYSEArca: HYD) is designed to track the high-yield segment of the municipal bond market, otherwise known as junk bonds. The ETF has 25 percent of its holdings in investment-grade bonds with the remainder in junk municipal bonds. This ETF happens to be one of my favorite bond ETFs due to the tax advantages, low volatility and high yield. The current SEC yield is 5.8 percent and an investor in the 35 percent tax bracket would receive a taxable equivalent yield of 9.0 percent.
United States Short Oil Fund (NYSEArca: DNO) inversely reflects the movements of the price of light sweet crude oil. As the price of oil falls, DNO should theoretically rise. A double dip will send the demand for oil down, and with supplies already at elevated levels, the price of oil will most certainly fall and the price of DNO will increase.
iShares Barclays TIPS Bond ETF (NYSEArca: TIP) is composed of a basket of Treasury inflation protected securities (TIPS). In the event of inflation, TIPS will help protect the current yield from deterioration caused by inflation. Inflation is not a concern during a double-dip recession, but I feel it will be an issue sooner rather than later, and that’s why I chose TIP over a comparable bond ETF. The 12-month yield is currently 3.1 percent.
iPath S&P 500 VIX Mid-Term Futures ETN (NYSEArca: VXZ) offers investors exposure to market volatility through futures contracts on the CBOE Volatility Index (VIX). Because the VIX typically rises with investors’ fears, VXZ can directly protect a portfolio from any sudden drops in the stock market. However, investors must realize there will be volatility in this position from day to day.
PowerShares Emerging Market Sovereign Debt ETF (NYSEArca: PCY) gives the DDP Portfolio exposure to bonds issued by emerging market countries such as
To give investors an idea how the double-dip portfolio has performed in the past, I backtested it and the results are interesting. Year-to-date (through Aug. 30) my “DDP” is up a cumulative 11.3 percent including dividend payouts. The biggest gainer was DRR, the double-short euro ETN, which rose 23 percent. The worst performer was SH, the inverse S&P 500 ETF. It rose 1.5 percent. During the same time frame, the S&P 500 has fallen 6 percent. The positive result for the DDP is not a big surprise; however, the large outperformance was a little shocking.
In 2009 the S&P 500 gained 23.5 percent and there’s no doubt most would assume the DDP took a big hit and lagged the market. The DDP did lag the market; however, the loss was not as bad as I had anticipated; losing just 1.6 percent last year. Helping the DDP avoid taking a major hit and remain near breakeven was the performance of PCY (up 27 percent) and GLD (up 24 percent).
From the beginning of 2009 through Aug. 30 of this year, the S&P 500 has gained 16 percent and the DDP is up about 10 percent; again lagging the overall market, but with what most would consider much less risk.
The real test is how did the DDP perform during the Oct. 9, 2007 to March 9, 2009 time frame when the S&P 500 fell 56 percent? Unfortunately only half of the ETFs in the DDP were created when the bear market began. However, of the five that were available to investors, here are their returns: +92 percent, +24 percent, +18 percent, breakeven, -4 percent. Even with half the numbers, it’s clear the DDP not only would have beaten the S&P 500, but it likely gained in value.
Finally, for the investors interested in yields, the current portfolio is projected to yield approximately 1.8 percent in 2010. If yield is your goal, DDP is not the best strategy; however, I have written several articles on yield that can be found on IndexUniverse.com.
My views regarding a double-dip recession above make clear that I’m not a big believer in the scenario. That being said, I do build diversified portfolios and this includes investing in a number of the ETFs mentioned in this portfolio. At this time, my firm currently has exposure to the following ETFs discussed in this article: SH, FXY, BIV, GLD, HYD, TIP and PCY. The allocation to the ETFs varies per account and not all clients own all seven ETFs. Keep in mind at Penn Financial Group we build personalized portfolios and therefore the holdings vary from client to client.
Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a Ridgewood, N.J.-based wealth management firm specializing in investment strategies using ETFs.