4 Factors Driving the Summer Market

06/23/2011 8:30 am EST

Focus: ETFS

Gordon Pape

Editor and Publisher, The Income Investor and the Internet Wealth Builder

By following these 4 forces in play, there are still smart investments to be had, observes Gordon Pape of Internet Wealth Builder.

Canadian stock markets are reacting predictably to all the turmoil and gloom. The fall in the S&P/TSX Composite Index became an official correction on Thursday, with a decline of more than 10% from its 2011 high.

Another 63-point drop on Friday left the Composite at 12,789.95, down 10.7% from the 2011 high of 14,329.49 reached on March 7. Year-to-date, the TSX is down 4.9%.

In New York, all the major indexes are still in the black for 2011—but only marginally. All are well off the highs reached earlier this year.

As I see it, there are four driving forces behind what we are seeing in the markets…

The News
Investors' attitudes are heavily influenced by what they see on television and read in the newspapers. Even professional money managers aren't immune.

An unrelenting diet of unsettling news is certain to have an impact on people's behavior when it comes to buy and sell decisions.

Who would buy Greek bonds today, even with ten-year issues yielding 17.5%? Who would put new money into US Treasuries if they seriously believed the American government would default on its debt? (The general assumption is that someone in Washington will blink.)

Stock markets always go into the doldrums in summer. Trading slacks off and volumes drop, as people leave for extended vacations.

As a result, volatility tends to be unusually high during this period. A negative news story or rumor can send a stock plunging much more quickly than might normally be the case.

The collapse of the share price of Sino-Forest (Toronto: TRE) is just one example. [MoneyShow's global editor Igor Greenwald wrote a compelling piece on the Sino-Forest's woes yesterday—Editor.] Research in Motion (RIMM, Toronto: RIM) is another.

Profit Taking
Stock markets did very well in the two years from March 2009 to March 2011.

On March 3, 2009, the S&P/TSX Composite fell as low as 7,547.26 in intraday trading. By March 9 of this year, it was up almost 90% from that level.

Many people made a lot of money during the run. It's hardly surprising that some felt the time had come to put at least a portion of those profits in their pockets.

For a while last year, fear went out of style. Few people talked seriously about a double-dip recession, much less a new Great Depression.

In 2011, the US housing market would finally pull out of its slide, and economic growth would start to gain momentum, or so the thinking went. It was that optimism that fed the commodities boom we experienced.

A year later, all that has changed. The pessimists are back in charge, and fear once again dominates greed in the minds of investors.

These four trends add up to a restless summer, one that will try the patience of investors. I continue to believe that another recession is unlikely, but we appear to be skating on thin ice—and any miscalculation, such as by the US Congress on the debt ceiling, could have widespread negative consequences.

That said, here are two recommendations based on what we're seeing now:

iShares iBoxx $ High Yield Corporate Bond Fund (HYG)
This US high-yield ETF invests in a portfolio of lower-grade corporate bonds. Most of the assets are held in securities rated BB or less, with a few rated as low as CC.

About three-quarters of the securities have maturities of between five and ten years, while most of the rest are under five years.

These units are a buy, but only for very aggressive investors.

PIMCO Income Opportunity Fund (PKO)
I expected this fund to be hurt by rising interest rates, but that hasn't happened yet.

The fund continues to be comfortably profitable, with a gain of 1.9% in the three months to March 31. Over the past year it posted an advance of slightly more than 6%.

I'd say buy this fund, but with the proviso that it should be regarded as a long-term core investment, not as a temporary safe haven.

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