Two Approaches to the Current Market

The market is basically where we were at the previous short-term bottom of June 14th: The S&P 500 and the Dow are slightly above the lows of one month ago exactly. Nasdaq slightly below.

Feel more bullish or bearish then last time? Frankly, I don’t think it’s healthy to have one’s feelings on the markets change in just a one month span, but that leads to a discussion better suited to a behavioral finance specialist, which I’m not.

We're seeing alot of television and online commentary on earnings season and geopolitical news these days. There’s little that’s changed in the global macroeconomic story from one month ago. The Bank of Japan did as expected. There’s still uncertainty about global economic growth and global inflation. I notice that VIX is showing intermittent high volatility (volatility of volatility?) -- it’s gone from its historical low range of 12, up to 20, down to 14, spiking back up to 24, down to 13 and recently back up to 18, all in about 2 months. These are big percentage changes and is very different from past 'volatile VIX periods' like April 2005 and October 2006.

There are really two ways I look at this opportunity. One, pile up some cash when possible. My feeling is that now is not the time to shop. We have not traded for our clients at all in May, June or July. My feeling during this volatile period has been that generally it’s too late to sell, too early to buy.

However, for the tactically inclined, these are the markets they’ve been waiting for. Short term trading (not day trading, but holding positions for no more than a week) is meant for these markets. If we were to remove all constraints on our asset allocation program (i.e. go well beyond global tactical asset allocation to something more like global macro), then we’d be trading the new levered and inverse ProShare ETFs as well as direct index futures. Former for smaller portfolios, latter for larger.

The point of the ProShare ETFs and futures is that smaller cash requirements are needed for these. This is obvious, but I’m not saying this to suggest that larger positions should be put in place using these levered instruments. My point is to keep as much cash as possible handy for potential buying opportunities. PowerShares WilderHill Clean Energy (PBW) on the energy side and Macquarie Infrastructure Company Trust (MIC) as an infrastructure play are two positions that have dropped a lot and look good for buying.

Gold and energy are also excellent for tactical trading. Whether it’s the stocks (GDX)/(XLE) or the underlying commodity (GLD)/(USO), these ETFs are great for various trading frequency ranges. We hold gold and energy as strategic positions for all clients regardless of risk tolerance for macro and diversification reasons.

On the other side are certain asset classes that look close to their highs. Real estate is a good example. streetTRACKS DJ Wilshire REIT (RWR) and iShares US Real Estate Index Fund (IYR) look fairly close to their highs.

I think it’s time to be selective on what you own, because if things continue the way they’ve been going recently, then cash may truly be king.