If you are like me, you are probably fed up with the recent volatility in the markets being primarily driven by the perceived road map of the Federal Reserve’s quantitative easing efforts. Investors must now be concerned with the markets' ability to weather the dual threats of rising interest rates and falling stock prices in an economic environment that has been artificially inflated with cheap money.
Just about every financial pundit is trying to divine the future of the stock and bond markets based on the comments and policy statements from the Fed. The media is dissecting every word that’s being said and even those that are not. This has created a very choppy sideways trading environment that has shattered the euphoric six-month rally in both stocks and bonds. Triple-digit up or down swings in the Dow Jones Industrial Average
(INDEXDJX:.DJI) are the new normal.
So the questions are: Where do we go from here, and how do you play this summer of volatility?
I believe that the key indicator to watch for in equities is the 50-day simple moving average on the SPDR S&P 500 ETF Trust
(NYSEARCA:SPY). As I have noted on the chart below, this has been a key level of support since the beginning of this uptrend and a break below that level presents a high probability of additional downside momentum in stocks. SPY is currently at a “make it or break it” moment that may determine how the rest of the summer unfolds.
If you have a large position in stocks at this juncture, I would recommend modestly pairing back on that exposure to take advantage of these higher prices. That will allow you to sidestep any additional volatility in the months ahead and keep some dry powder on the sidelines in the event that an opportunistic buying opportunity presents itself.
I recently mentioned several ETFs on my dividend equity buy list
that I will be looking to purchase into a solid correction. In my opinion, a correction that forced the price of SPY back to its 200-day moving average could present an excellent buying opportunity in stocks. It never seems to happen that easily, but if you make small purchases during the midst of the next pullback, your average cost will be much more advantageous than simply weathering the volatility.
Fixed Income: Bubble or Buying Opportunity?
The bond market has been particularly fearful of the eventual end to quantitative easing and the return of rising interest rates. The yield on the CBOE 10-Year Treasury Index
(INDEXCBOE:TNX) rose to just over 2.2% from a low of 1.6% this year. That spike sent bond prices spiraling downward and did significant damage to interest-rate-sensitive ETFs such as the iShares 20+ Year Treasury Bond Fund
(NYSEARCA:TLT), iShares TIPS Bond Fund
(NYSEARCA:TIP), and iShares Barclays MBS ETF
The target that I am closely watching in interest rates is 2.4% on the 10-Year Yield Index which is a key line in the sand on a 2-year chart. If we cross that mark, rates could easily extend to 3% or higher. Due to the strong likelihood of the Fed intervening, I believe that outcome has a small chance of ultimately becoming a reality, and that the majority of the move in interest rates has already been made this year. However, if you are holding intermediate or long-term bond positions, you should use the 2.4% level as an important risk management point for your portfolio.
I believe it is still too early to abandon fixed-income altogether, so the strategy I am implementing for income clients at our firm is concentrating on sectors with short duration and low-to-mid credit quality to enhance the yield on the overall portfolio. Investments in senior loan funds such as the PowerShares Senior Loan Portfolio
(NYSEARCA:BKLN) offer attractive yields with minimal exposure to changes in interest rates. I am actively avoiding any high quality bond positions with average durations above five years because low yields and high volatility don’t make the reward worth the risk.
One outcome I think we can all agree on is that volatility is here to stay, and we are most likely still in for a Bernanke-induced ride in interest rates over the next several months. This is why it is important to be nimble with the expectation that higher rates will create better value in bonds.
No one will be able to perfectly forecast the future of stocks or bonds, but with some subtle adjustments and eyes on key indicators, you can take a proactive approach in these unprecedented times. I believe that now, more than ever, it is important to be mindful of the risks and approach every position with the mindset that risk management is paramount.
Read more from David Fabian, Managing Partner at Fabian Capital Management:
5 Rules Every ETF Investor Should Follow
Stocks: Risky Summer Ahead
The Strategic Approach to Adding Preferred Stocks to Your Portfolio
No positions in stocks mentioned.