Financial markets must get ready for life without Quantitative Easing (QE). According to a front-page article published on the Wall Street Journal Saturday, the Fed is mapping exit from stimulus. This means that interest rates and exchange rates will begin heading north, changing the parameters of the game. How can investors prepare their portfolio for this prospect?
1. Stay away from precious metals that have been rallying on the prospect of an infinite round of QE and an imminent collapse of the dollar; and ETFs that invest in them like SPDR Gold Shares (NYSEARCA:GLD); iShares Silver Trust (NYSEARCA:SLV); Freeport McMoRan Copper and Gold (NYSE:FCX); and Palladium (NYSEMKT:PAL), as discussed in a separate piece.
2. Stay Away from momentum stocks. Momentum investing is a strategy based on hype about an investment theme, a new product or a new industry that captures and captivates the investor mind-- at times when money is cheap. In the late 1990s, the theme was telecommunications and networking, with momentum funds flowing into companies like Ciena Corp. (NYSE:CIEN) and JDS Uniphase Corp. (NASDAQ:JDSU). Now the theme is social media and web-based companies, like Netflix, Inc. (NASDAQ:NFLX), Open Table Inc. (NASDAQ:OPEN), and LinkedIn Corp. (NYSE:LNKD), Groupon (NASDAQ:GRPN), and Tesla Motors (NASDAQ:TSLA). Momentum investing can be very rewarding as long as it lasts. But it can result in hefty losses once it fades away, usually when liquidity dries up.
3. Stay away from U.S. Treasuries - and Treasury ETFs like TLT. Though U.S. Treasuries are the first investment to come in mind when the economy heads into recession. This time yields are already near record low levels, so any gains from here will be limited.
4. Buy an ETF that is short on U.S. Treasuries like the ProShares UltraShort Lehman 20+ (NYSEARCA:TBT) or ProShares UltraShort Lehman 7-10 (NYSEARCA:PST). The problem for investors, however, is that both funds bet against the daily price movements of U.S. Treasuries, and therefore, they do not make good long-term bets.
5. Trim your positions in high dividend paying stocks.
A few words of caution: While a Fed exit is eventually imminent, it cannot be timed. That's why investors should place these bets gradually rather than at once, monitoring closely the indicators that may prompt the Fed to move in this direction like the unemployment rate.
Additional disclosure: Short on NFLX