The Fed’s mandate is to maintain stable prices and to maximize employment. Inflation still remains well below the Fed’s target of two percent. This is a subdued economy, and as long as that continues the Fed has no reason to tighten. Although the Fed states they are ready to taper their balance sheet expansion as soon as they can, they did not set a date for this. It is obvious that tapering by the winding down of securities buying by the Fed is coming. The Fed also projects that the unemployment rate could fall as low as 6.5% by 2014, which is the condition it sets to raise interest rates. Most Fed officials expect that rate increases will be held off until 2015, which gives the economy time to get on a more secure footing.
Central bank policy makers say they intend to keep short-term rates close to 0% until the unemployment rate falls below 6.5%, as long as expected inflation stays under 2.5%. Low inflation gives the Fed latitude to continue its program of buying $85 billion worth of bonds per month, which is meant to keep interest rates low and spur economic growth.
It is doubtful that future market action could rely only on this one eventuality. It seems more likely that anticipating the Fed is the latest obsession by market players and prognosticators. When the Fed slows its purchases, does that necessarily mean that the market will pull back? It seems that this is another pat premise that some pundits keep trumpeting -- that Fed tightening automatically means a market pullback. The market never fails to surprise, and the market could just as well go up when the Fed tapers off its expansion. The reasoning could be that if the Fed does taper, it would be because the economy is doing better, and doing well enough that it does not need Fed help. And investors could jump into the market.
Meanwhile volatility has increased amid the realization that the bull leg may have been exhausted and the market can go down. In fact, there is much bearishness, and the individual investor is still mostly on the sidelines. With valuations reasonably low, investors and traders can buy on weakness for a longer-term upside move.
The three sectors that are overweighted in the S&P 500 High Beta Index
(INDEXSP:SP500HBETA) have been among the sectors that have outperformed the S&P 500 Index
(INDEXSP:.INX) over the last month or so. These are the financial, technology, and energy sectors. These will probably continue to outperform. At some point emerging markets should join in the market advance. The good economics of the emerging markets countries are not being reflected in their stock prices.
Emerging Markets Outlook
There are large divergences between the economic outlooks for the different emerging markets, so it is not accurate to lump all emerging markets together. Russia is difficult to assess, and although companies in that country are reasonably priced, the region could be a value trap. Still, the best time to buy an asset class is when there is uncertainty. Russia has that, and also has big upside possibilities.
Among the possibilities is that a large dividend increase in the Russian giant oil company Gazprom OAO (ADR)
(OTCMKTS:OGZPY) could make that company and the other Russian oil and gas stocks jump. If there is a big increase in Gazprom’s dividend, it will probably not happen until next year.
For pure Russia exposure, investors could buy the Van Eck Market Vector Russia ETF
(NYSEARCA:RSX), which is highly concentrated to the resource sector. RSX gives exposure to about 42% energy and 18% base materials sectors. Another ETF to consider is the WisdomTree Emerging Markets Dividend ETF
(NYSEARCA:DEM). DEM includes in its composition about 12% Russian stocks, including about 5.35% Gazprom. DEM has underperformed the S&P 500 Index for some time now, sells at only 10 times earnings, and pays a dividend of 3.3%.
For emerging markets exposure without Russia, investors could consider the WisdomTree Emerging Markets Small Cap Dividend ETF
(NYSEARCA:DGS). Even though this is a small-cap fund, over the past five years it has been less volatile than the MSCI Emerging Markets Index
(INDEXNYSEGIS:EMX), and over the past year it was even less volatile than DEM. Because it is a small cap ETF, DGS has little exposure to state-owned firms, which are found in Russia.
Buying Into the Energy Sector
The energy sector is another outperforming sector, and part of the reason is that there is so much domestic activity. The US reached a total liquid fuel net imports amount of 12.5 million barrels per day (bbl/d) in 2005. Since then, imports -- including crude oil and petroleum products -- have been falling. Total net imports fell to 7.4 million bbl/d in 2012, and are estimated to decline to an average of 5.7 million bbl/d by 2014. Similarly, the share of total US consumption that was met by liquid fuel net imports peaked at more than 60% in 2005, and fell to an average of 40% in 2012. It is expected that the net import shares will fall to 30% in 2014, which would be the lowest level since 1985.
Over the last several years energy production has been one of the bright spots in the US economy. New technology has allowed the industry to extract oil from sources that used to be uneconomical or impossible to access. US crude oil production bottomed out in 2008, and is estimated to rise from that bottom in 2014. Natural gas production has risen sharply also.
This gives American manufacturers an advantage over international competitors. The price differences exist because natural gas is expensive to make into liquids and to transport. A low gas price also helps consumers save money, giving another competitive advantage to the US economy in global competition.
A way to benefit from the energy renaissance is by buying the oil explorers and producers and the oil and gas service companies.
PowerShares offers two ETFs that give exposure to this sector. The PowerShares Dynamic Oil & Gas Services ETF
(NYSEARCA:PXJ) contains US companies that are engaged in drilling oil and gas wells, that manufacture oil and gas field equipment, or that provide oil field services, such as well analysis and platform engineering. The PowerShares Dynamic Exploration and Production ETF
(NYSEARCA:PXE) contains US companies that are engaged in the exploration and production of natural resources. These companies extract and produce crude oil and natural gas from offshore wells and land-based wells. These companies include petroleum refineries that process crude oil into products such as gasoline and automotive lubricants, and companies that gather and process natural gas and manufacture natural gas liquid.
Editor's Note: Max Isaacman is the author of Blizzard of Money, Winning with ETF Strategies, Investing with Intelligent ETFs, How to Be an Index Investor, and The NASDAQ Investor.
The author and/or his clients have positions in PXE, DEM, DGS.