Where is the Yin for the market Yang?

Yin and Yang in Korean philosophy are opposing forces that are interconnected.  Portfolio construction in the modern world is all about correlation and opposing forces.  Correlation, as it relates to investing, is how two assets move relative to one another.  The application of correlation in portfolio construction is to have some non-correlated assets in your portfolio so as to always have something moving up.   The problem currently is that correlations have converged throwing asset allocators for a loop.

Common Knowledge

Behind most asset allocation strategies lies Modern Portfolio Theory (MPT).  MPT claims that diversifying your portfolio with non-correlated assets will do you good.  In “theory” that sounds great but what happens when everything goes up and down together?  Remember when the fall in the markets really got going in September, 2008?   Just about everything fell from stocks to bonds to commodities.  Being diversified did very little to save your portfolio (this is why I am not a big believer in MPT) but understanding correlation is still important.  In the run up we have had since March, 2009 just about everything is going up – stocks, commodities, metals and bonds.  While this is not what we know to be normal it is the reality we are living with for now.   This reality is not only unsustainable but dangerous as something is going to fall because not everything can be a winner.

Yin for today’s Yang

The talk of asset bubbles is almost a daily discussion in the media thanks to loose monetary policy.  Many investors are concerned that when Europe and the US unwind the stimulus packages and raise interest rates markets may be in for another punch in the gut.  If that is the case what will move up?  I looked at a 126 day correlation matrix with 200 ETFs which includes broad US markets, European markets, emerging markets, commodities, metals and more.  What did I find?  The ETFs (that are not inverse or short funds) with the lowest correlation were iShares 1-3 year Treasury Bond (ticker SHY), PowerShares Dollar Bull (ticker UUP), and Currency Shares Yen (FXY).  I find it practical, at this point, in the market to understand what may move up if equities and commodities start to pull back.

Many Moving Parts

The strange environment we find ourselves in today is actually pushing investors away from the above mentioned investments.  Investors should not be faulted for going away from these investments as their long-term prospects are not good.  But, to be truly diversified in the current environment they should be considered for a diversified portfolio or at least put on the break in case of emergency list.

Investors have hesitated with SHY believing that a strong stock rally would take prices down as investors sought more risk and moved out of treasuries.

For UUP the long-term outlook is negative.  In a typical environment a strengthening economy and stock market is good for the dollar.  Today, a strong dollar pushes down stocks and strong stock markets push the dollar down.  Long-term the dollar will likely fall as government policies are giving the dollar no where to go but down.

For FXY the Yen is still considered a strong currency but the current economic woes and finding themselves in a deflationary environment may put downward pressure on the Yen if the Japanese government decides to sell the Yen to bolster the economy.

The bottom line here is that any of the three above ETFs should make a nice place to hide some money in another global stock market sell off.  Keep in mind if you move into these holdings it should be for their counter movement to equities in the current environment – not long-term prospects.

Disclosure Statement: ETFGPS is a blog that Navigates The World of ETFs. Sustainable Investment Strategies LLC is a Registered Investment Adviser in the State of Maryland, and does hold positions in the SHY ETF mentioned at the time of writing. Investors who are interested in money management services may visit the Sustainable Investment Strategies LLC web site

Tagged as: Bonds, fxy, shy, uup