McCall’s Call: Double-Dip Portfolio Review

October 05, 2011

A year later is as good a time as any for a double-dip ETF portfolio review.


The third quarter was the worst for U.S. stocks in three years, as the S&P 500 fell by 14 percent and it’s now near a new 52-week low. Investors who have been in defensive ETFs could have been able to avoid the most recent sell-off. But, has it been a good idea to be in these defensive investments over the last 13 months?

Matthew D. McCallI’ll answer by taking a look back at a “double-dip recession” portfolio that I laid out here in September 2010 in a piece titled “Hot ETFs For A Double Dip.”

Since that time, the SPDR S&P 500 ETF (NYSEArca: SPY) is up 4.9 percent through the end of the quarter, including dividends. Many investors may find it hard to fathom that stocks are up over the last 13 months, but, until the third quarter, they were performing quite well.

Even though the double-dip ETF portfolio is set up for a recession and a bear market, it was still up 1.1 percent over the last 13 months, which may come as a surprise. Even more important is how the portfolio held up during the sell-off that began in early May.

From the end of April 2011 through the end of September, SPY fell 16 percent while the double-dip ETF portfolio gained 14.4 percent. The 30 percent difference in a mere five months shows that a recession-proof portfolio isn’t just about playing defense, but can also generate profit during overall market weakness.

The Portfolio

Each of the 10 ETFs in the portfolio were equally weighted when I designed it, and dividends were accounted for in the total returns. From Sept. 1, 2010 through the end of September, four of the ETFs had negative returns and the other six rose.

During the market sell-off from May 1 through the end of September, all ETFs in the portfolio had positive returns—four in double digits. Keep in mind this is with the SPY down 16 percent.

The ProShares Short S&P 500 ETF (NYSEArca: SH) is an ETF that moves 1-for-1 the inverse of the underlying index. During the 13-month period, the ETF fell by 11 percent, but during the market sell-off, SH was a great hedge with a gain of 15.3 percent.

This ETF is about as straightforward as it gets when it comes to hedging a portfolio against an overall market sell-off. Bear in mind, this inverse ETF rebalances daily, so returns over time can deviate significantly from the index. Therefore, most people don’t hold such ETFs for long periods.

Currency Matters

The Rydex CurrencyShares Japanese Yen ETF (NYSEArca: FXY) hasn’t taken a hit during the sell-off. Often considered a safe haven, the yen has held up well during up and down markets.

Over the 13-month span, FXY was up 9 percent, and during the sell-off, it gained 5 percent. It’s been a reliable hedge during bear markets and it holds up fine when stocks move higher. This is the No. 1 reason my firm owns shares of FXY.

The Market Vectors Double Short Euro ETF (NYSEArca: DRR) meanwhile lost 14.6 percent over the 13-month span, as the dollar fell against the euro for a large part of the first half of 2011.

But as stocks began to fall and the debt crisis in Europe started creating anxiety in financial markets , the greenback became a safe haven for currency investors. This sent the euro to new multimonth lows, and DRR gained 19.3 percent during the sell-off.

Typically I wouldn’t recommend a leveraged ETF for the long term; however, there’s no other short euro ETF now available. As I noted regarding the daily rebalancing of the inverse ProShares S&P 500 ETF, be careful when using leveraged long or short ETFs.



Fixed-Income Options

The Vanguard Intermediate-Term Bond ETF (NYSEArca: BIV) rallied to a new all-time high in September as stocks were breaking down. During the market sell-off, the ETF was up 6.6 percent, a bit less than the 6.8 percent gain it achieved over the entire 13 months.

The ETF will clearly outperform in a down market and could suffer losses if stocks rally in the future. The current yield on BIV is 3.7 percent.

Municipal bonds have had an interesting 13 months, and the Market Vectors Municipal High Yield Bond ETF (NYSEArca: HYD) had its fair share of volatility.

The ETF finished the 13 months with a gain of 4.3 percent, but did even better, with a gain of 8 percent, during the sell-off. Because the monthly dividend is tax free, this ETF is best used in a taxable account. We own a position in HYD and feel with the current tax-free yield of 6.0 percent, it’s a no-brainer as a place to park some cash.

The iShares Barclays TIPS Bond ETF (NYSEArca: TIP) rallied to a new historic high in early August as money flowed into all government bond ETFs.

Not surprisingly, the ETF was up 5.5 percent during the market sell-off. But it was also up 10.6 percent during the entire 13-month span, making the ETF attractive as a hedging play in all market e

A low-volatility bond ETF is the PowerShares Emerging Markets Sovereign Debt ETF (NYSEArca: PCY). The returns for both the sell-off and the longer-term 13-month period were identical, at 0.2 percent.

The late 2010 sell-off was canceled by a rally from the February low—and a dividend yield of 5.4 percent. In the end, the ETF is a good way to gain exposure to bonds that are likely to perform better than those from developed countries like the United States.

Gold And Oil

The SPDR Gold ETF (NYSEArca: GLD) has been the ultimate safety play in the past decade as the dollar has steadily lost value to a host of currencies.

However, in the past month, the precious metal has been selling off heavily as the dollar rose and gold owners took profits. Still, over the 13 months since I unveiled my double-dip portfolio, GLD was the biggest winner.

It has risen 29.9 percent in that period and, even with the recent swoon, it rose 3.7 percent during the sell-off period. So, even after the pullback I continue to like GLD, and it remains my firm’s largest holding.

As long as we’re talking about commodities, let’s talk about oil. When the global economy slows and stocks fall, oil typically falls too.

This is why the United States Short Oil ETF (NYSEArca: DNO) was able to gain 37.7 percent during the market sell-off. DNO didn’t fair as well over the 13-month span, as it fell 5.2 percent. At this time I wouldn’t own DNO, as NYMEX oil is back near support in the low-to-mid $70s, and a move higher is likely into the end of the year.

VIX Might Not Be Worth The Vexation

If the goal is to add a volatile ETF to the portfolio, then why not invest in volatility? The iPath S&P 500 VIX Mid-Term Futures ETF (NYSEArca: VXZ) will increase in volume as the VIX futures on the CBOE rise.

This typically occurs as fear increases and stocks are selling off sharply. During the market sell-off, the ETF was up 42.7 percent, but that wasn’t enough to put it into positive territory for the entire 13-month time frame, during which it lost 19.1 percent.

This ETF is a very aggressive choice. It’s portfolio insurance where premiums are often lost, and is thus too aggressive for the majority of investors. So, please, think twice before playing with the VIX-related ETFs.

All Systems Go

If I were to build a double-dip portfolio today, I see no reason to change the current allocation.

However, after a big move down in the market, the odds of stocks going much lower are not as high, as much of the potential bad news is baked into prices.

On the other hand, even if stocks do rebound, the odds of this portfolio taking a big hit is low, as evidenced by the action during the 13-month span. As always, please do your due diligence before considering any of the ETFs above.

Matthew D. McCall is editor of The ETF Bulletin and president of Penn Financial Group LLC, a New York-based wealth management firm specializing in investment strategies using ETFs.


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