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Friday, January 13, 2012
WAKE-UP CALL MOVES EQUITY ETFS DOWNWARDS
Friday the 13th took on a new meaning as a fear of downgrades with Standard and Poor’s issuing 9 sovereign downgrades in Europe. In what could’ve been a much uglier day, the S&P 500 finished down only 0.49%. Regardless, the Euro remains at $1.27/Euro, signaling overall weakness in the Eurozone.
Luckily, the expectations of a downgrade given the warnings resulted in a lighter blow to markets than what might’ve happened had it been an unexpected event. For instance, the VIX rose just a little more than 2%.
While volatility might be down, investors’ actions suggest otherwise as the 10-year Treasury yield fell down to 1.85%. So while equities aren’t necessarily getting hit very hard, there are significant inflows into less risky government securities such as Treasuries in an attempt to find a safe haven. In other words, we are very much in risk on mode.
After a couple months of warnings, Standard and Poor’s finally downgraded France one notch down from its AAA status, adding further strain on the European core. Hopefully, Germany won’t be next.
The ratings agency also doled a downgrade out to Italy, giving it BBB+ status, classifying Italy as non-investment grade. Portugal and Spain were also downgraded 2 notches, raising serious debt concerns. How the PIIGS will climb out of this deadly debt spiral with what are likely to be higher borrowing costs is beyond my understanding.
In the tug-o-war between Greece and its bondholders over debt restructuring, it looks like bondholders are pulling their weight as talks were postponed today. At this point, Greece’s financial credibility is simply extinguished. It’s time to put up the white flag and opt for orderly default.
In the U.S., exports dropped 0.9% according to the Department of Commerce, widening the trade deficit. Although a stronger dollar helps on the domestic demand side, it’s not good for export-dependent manufacturing, which is already struggling.
With regards to our trend tracking indexes, the fact that the Domestic TTI is at +3.03% continues to warrant some domestic equity ETF exposure. However, we’re still steering clear of international ETFs since the International TTI is at -4.97%.
Although markets didn’t react very sensitively to downgrade news, I find these developments quite worrisome. In what will likely trigger higher borrowing costs due to increased risk perception, I’m not sure how European countries will be able to afford to finance their debt.
We’ll have to see if today’s negative sentiment rolls up into something bigger next week.
Have a great week.
READER Q & A FOR THE WEEK
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A note from reader Mel:
Q: Ulli: I’m not sure if my comment last week got through. I appreciate your blog greatly. I know that today you are saying that “for those wishing to make some equity ETF additions, now might be an opportune time.”
I understand that international ETFs are still off the table, but the TTI for domestic equity crossed up over the trend line in October. But as I have followed your blog, you seemed to be saying we shouldn’t follow that signal but stay in cash and bonds. Was that interpretation right? Do you advise domestic equity exposure now? Do you have a rough percentage in mind for equities vs. cash and bonds? Or are you still avoiding the equity market?
Thanks so much for your blog, and in advance for answering my query.
A: Mel: I have always favored bonds and cash along with some selected sector funds. I use the HV ETF Cutline report to make my selections from those ETFs that have crossed their trend lines to the upside. There are more to choose from now than a few months ago. The amount of allocation depends strictly on your risk profile. Have I increased some of my equity holdings? Yes, I have added exposure.
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