In Mid-May we saw the first signs of a market pullback, and volatility crept into major indexes as news emerged surrounding the president’s Russia affairs, as well as the noise around the firing of James Comey. The market saw the worst declines since September during the third week of May when large caps fell about 2%, though they quickly recovered only two days later. On June 9,markets were disrupted again, led by a rout in technology stocks, as investors reacted to a sharp run-up since the elections.
The concern is that President Donald Trump and his administration will be unable to push through economic policies, which could lead to both uncertainty and potentially volatility re-entering the broad-based equity markets. More specifically, expected tax cuts have been the leading impetus for pushing equity markets ahead, and now it looks like tax reform and fiscal stimulus are going to at least take longer than we have expected.
Were these last two pullbacks just hiccups with our ever-running bull market set to recommence its steady positive climb? Or is it time to think about repositioning portfolios and looking for short-term trades that match up with the market’s reaction to current events? While we do not offer an opinion on the future of the markets, we do offer various tools advisors can employ to express their opinions on short-term market movements for opportunistic alpha, or longer-term portfolio solutions to protect or profit from broad-based market and sector declines.
Here is an idea for uncertainty around a pullback: utilities. If the flight to safety is on your mind in the short term, trading utilities is a way to add defensive investment tools to a portfolio. Utility stocks have been known to do well when the S&P 500 pulls back; they tend to be stable investments for income and noncorrelation to broad-based equity indexes. Using a utilities ETF provides both geographic and single name diversification. If you are an investor that is ahead of the game, or perhaps have already selected your single name electric, water and gas or one-beta ETFs tracking the various utilities indexes available, you might consider an inverse ETF that targets the sector.
Where can we find some growth and potential upside? We’ve seen positive momentum outside of the U.S. Developed and emerging markets have been cheap for some time now, and strengthening compared with US stocks. Year to date, developed market stocks have been outperforming their U.S. counterparts, returning 12.34% through early May, versus the U.S., with positive 7.5% growth. We can put a spotlight on Japan as well, where we see the region as both a stand-alone, returning 7% year to date; and as a major component of the developed market index with a 23% weighting.
Europe, Japan and emerging markets have had a good global growth story as of late. GDP growth for Europe and Japan in the first quarter was around 2%, stronger than the U.S. The earnings growth data in emerging markets has also been positive, receiving a push from a weaker dollar. There are several indexes that a sophisticated, tactical trader may target when looking for short-term trading opportunities within these regions, including the MSCI Emerging Markets Index, MSCI Developed Markets Index and MSCI Japan Index
We’ve talked quite a bit about interest rate hikes, and how to both trade opportunistically in the short term around Federal Open Market Committee announcements, how to hedge duration or take a downward view on falling bond prices. Bull and bear ETFs that target Treasurys are alternatives to consider in an active Fed environment. They can be used to hedge out a great deal of duration exposure, or simply to take an inverse view.
But the question is, what other opportunities can we think about in a rising rate environment? Regional banks have been a hot topic. We’ve seen post-election returns of nearly 50% in the regional banks leveraged ETF. Some wonder if that trend will continue. Well, if we consider that deregulation of big banks may come into play and effect large-caps, regionals would be less likely to feel the burn here. Regional bank revenues are not centered on trading activity. Regional banks stand to gain revenue in an interest rate rising environment where the spread on interest earned on loans vs. interest paid on deposits lagging leads to potential profit. On the other hand, if you are worried about the stale growth of loans in general, credit issues and auto loans, then considering an inverse view with a regional banks bear fund may be an interesting portfolio position in the short term.
Finally, we have the dual tale of retail. The retail sector fell about 2-3% around poor Q1 earnings. We saw names like Macy’s down 17%, exacerbating the decline of the sector. However, Consumer Price Index tells a different story. The retail sector has lagged the S&P 500 year to date, returning -3% versus the S&P 500 return just north of 7%. But we’ve seen a reversion to the mean with momentum indicators trending up, and Relative Strength Index levels around 45 prior to the oversold reversal. Tactical investors can consider getting in low with a short-term trade that targets the retail sector.