Take a Spring Break From Stocks
Larry is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Most market news is negative lately. Maybe it’s time for the stock market to take off for spring break. A little sun and beach make a world of difference.
The bad news adds extra meaning to the old stock market adage: “Sell in May and go away.” Make that mid-April.
Downgrades are happening again. On April 5, Egan Jones Rating Company downgraded the U.S. government debt from AA+ to AA. Egan Jones first downgraded the federal debt in 2011 from AAA+ to AA+ -- which was quickly followed by Standard and Poor’s with a similar downgrade. Could this second downgrade by Egan Jones force S&P to follow again? Any downgrade has a profound effect on the debt and increases borrowing costs. More risk equals higher carry costs.
The next day’s monthly unemployment report provoked the recent market sell-off. Investors were disappointed that fewer new jobs were created than estimated by the Labor Department. The jobs recovery remains out of sync with the slowly improving economic situation. Add to that more jitters about Spain and other shaky European nations. Bottom line: The economic recovery remains fragile at best.
Further, the end of stimulus and investor qualms about the strength of this recovery do not augur well for continued stock market growth. Federal Reserve Chairman Ben Bernanke is vocal about not implementing a third round of stimulus, known as quantitative easing. That’s where the Fed buys bonds to pump cash into the economy and lower interest rates. The current round ends in June.
Market risk is higher now. Despite the rally that started Wednesday after five days of retreat, the best we should expect is for the markets to trend sideways.
After a spectacular start in 2012, it is no surprise that the markets will correct as investors harvest their profits. The same thing occurred following strong first quarter performances as in 2010 and 2011. This year, after such a strong start, the decline could be more pronounced.
My firm has lightened its positions in stock funds and junk bond funds. For instance, we have sold our entire holding in SPDR S&P MidCap 400 (NYSEMKT: MDY). Mid-cap stocks, which this exchange-traded fund tracks, are slightly less risky than their small-capitalization brethren yet like small-caps do well in the early stages of a market recovery. In 2009 and 2010, mid-caps far eclipsed the S&P 500. They outperformed during the first quarter of 2012, as well.
Junk, of course, is highly correlated to equities. Because the stock market is the collective forecast of where the economy and corporate performance are headed, high-yield prices are affected. Reasoning: If the economy sputters, then junk-rated companies face a tougher time servicing the heavy debt they carry.
Where do you go when you leave the equity markets in spring?
There is opportunity in ETFs with a bond focus, particularly in Treasury securities. Old favorites during periods of negative market transition are climbing – and likely will keep going up. Whenever bad news resurfaces, safety-minded investors are sure to crowd into Treasury paper.
The first ETF covers the widely followed Barclays Aggregate Bond Index, made up of investment-grade bonds. Some 40% of them are federal government paper. So this fund is the perfect place to hide in. Over the past 12 months, which includes the 2011 mid-year stock slump and the rally that started in October, AGG advanced 8.6%. Through this turbulence, the S&P 500 trailed with 4.5%.
With inflation inching up again, SHY makes sense. Partly thanks to rising oil prices, a trend that shows no sign of abating, the Consumer Price Index is up 2.9%. Eventually, inflation and economic recovery will lift interest rates – and that hurts prices. By concentrating on short-term Treasury securities, as SHY does, you escape much of the damage.
If you are worried about inflation, also take a look at iShares Barclay TIPS Bond (NYSEMKT: TIP). This ETF is a good and cheap (expense ratio: 0.2% of assets yearly) way to gain exposure to Treasury Inflation Protected Securities. Individual TIPS are en vogue and their price has climbed. This fund regularly beats the Barclays Agg index: For the past 12 months, it is up 12.8%, four percentage points better than the index.
We remain conservatively invested but we understand profits will be tougher to achieve from here on out.
George Clausen is president of Clausen Capital Management in Charlotte, N.C.
The Motley Fool has no positions in the stocks mentioned above. This post was written by George Clausen and edited by Larry Light, editor-in-chief of Advice IQ. Neither owns shares of any of the companies mentioned above. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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