Turning some of your profits into cash will help prepare you for the coming dip and its ensuing opportunities, says David Fabian of Fabian Capital Management.
Comments from Fed Chairman Bernanke stoked the fires of QE tapering and rising rates, roiling the markets. The sell-off pushed the SPDR S&P 500 ETF (SPY) below its 50-day moving average—a key technical level.
This could be the start of a more profound correction in stocks, which is why it's important to review your invested positions and assess the opportunities.
Growth investors should consider pairing back on their equity exposure in preparation for a volatile summer. The first step is to move a portion of your portfolio to cash.
In the midst of a "normal" correction, I would look at opportunities to hedge or balance out the remaining stock exposure in your portfolio with non-correlated positions. These can include Treasury bonds, precious metals, or even short positions. However, these are far from normal circumstances, and the risk and potential rewards of each asset class should be reviewed.
Treasuries. The price action of the iShares 20+ Year Treasury Bond ETF (TLT) and iShares 7-10 Year Bond ETF (IEF) shows that both the intermediate and long end of the bond spectrum have been hit the hardest by rising interest rates. So far, TLT has fallen more than 16% from its highs, while IEF is off more than 6%.
I am not ready to declare the 30-year bond bull market dead quite yet, so these funds should still be on your watch list. If we see a return of stability in interest rates and a continued push lower in equities, I believe that investors will realize that there is greater value in bonds than in stocks right here.
They should be used as trading positions and not long-term investment themes. Ultimately, we are going to see a return of much higher rates, so keep your stop losses tight.
Precious Metals. The SPDR Gold Shares (GLD) has disappointed many gold bugs, as gold has fallen 28% from its October 2012 high. It recently hit new 2013 lows, and has not found a bottom quite yet. The iShares Silver Trust (SLV) has experienced even greater losses this year.
Precious metals have traditionally been a hideout for growth investors during volatility, but they are not showing a convincing pattern of stability right now. I am closely watching both GLD and SLV for a sign of trend or momentum change; however I am not holding them as a safe haven at this time.
Short Positions. I am not a huge fan of going net short the market. Taking a one-sided stand against stocks has a much greater chance of failure than success, unless you are a very short-term and disciplined trader.
However, I can see the benefit in using a small short position to hedge off the risk of a correction in highly appreciated stocks that you don't want to sell.
Broad-based short ETFs such as the ProShares Short S&P 500 (SH) or the ProShares Short QQQ (PSQ) will give you single-beta inverse exposure to large-cap stock indexes. But you should use a tight stop-loss on these positions to manage the risk of a snapback rally.
I would caution those that are thinking about shorting interest rates right here, using the ProShares Short 20+ Year Treasury Bond (TBF). Bonds have already made a big downward move, and adding a rising interest rate fund at this point is very late to the game.
In rare times like these when we are seeing stocks, bonds, and commodities fall in tandem, the best place to hide out may be cash. If you have already raised cash in your portfolio, then you can start building your watch list for new opportunities that you want to purchase into this dip.
The SPDR S&P Regional Bank ETF (KRE) has been remarkably resilient in the face of this equity sell-off, and may continue to outperform the rest of the market going forward. I don't currently have exposure to this ETF, but it is on my watch list.
The next six months are not going to look anything like the last six months. Keep your expectations for returns in line with current economic conditions and adjust your risk tolerance to weather this volatility, so that you come out on the other side a winner.
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