The word around the financial community right now is "boring". The stock market has entered a phase of miniscule price movements, low volume metrics, a multi-year low in volatility, and uncertain economic data. In short, equities are boring us to death one slow day at a time.
The problem is compounded by the fact that the SPDR S&P 500 Trust ETF (NYSEARCA:SPY) is sitting close to all-time highs and defied nearly every "top" that experts have predicted. This has many traders sitting on their hands or frustrated with the lack of movement in existing positions. No one wants to add up here, and no one wants to make the mistake of shorting this resilient market either. It is a conundrum that can only be resolved through time and price.
Months of choppy action in equities have resolved in SPY gaining a modest 5% on the year. However, the underlying sector movement has shown a much different story. The Consumer Discretionary Select Sector SPDR ETF (NYSEARCA:XLY) is sitting in negative territory and clinging to life support, with first-quarter GDP showing its first negative print in years. On the other side of the spectrum, the Utilities Select Sector SPDR ETF (NYSEARCA:XLU) has gained more than 14% this year on the back of falling interest rates and defensive repositioning.
The most recent data on the CBOE Volatility Index (VIX) shows a reading under 12, which translates to a lack of fear and general complacency in the market. In addition, investor sentiment readings continue to show the majority of investors in a neutral stance, i.e. lacking a bullish or bearish conviction to gain an edge.
Everyone appears to be waiting for the next shoe to drop, while stifling a yawn and looking over their holdings.
So where do we go from here?
The majority of active investors are trying to divine what the next big move will be. After months of rallying in tandem, stocks and bonds are at the top end of their range and are starting to show some signs of indecision. The two most likely scenarios of course are: (1) stocks continue higher, with a sell-off in bonds or (2) the much anticipated equity correction materializes this summer, and interest rates fade alongside them. This would be supportive of bond prices, with the exception of credit-sensitive holdings.
While there is an outside chance we will see additional positive correlations in both stocks and bonds, I believe that we are overdue for a divergence that lends itself to a more traditional balance between the two asset classes. This would assert a more traditional ebb and flow between risk and safety that would break the cycle we have seen so far this year.
In the very near term, I would not be surprised if SPY dipped back down to re-test its 50-day moving average and provide an additional layer of intrigue for bulls and bears.
These tests have been a common occurrence every few months as we have made our way higher, and will provide another opportunity to shape portfolio changes based on fundamental or technical data.
Probably the one thing that would catch the majority of participants off guard right now would be a severe drop in stocks that ratchets up volatility, volume, and risk. Similar to the sharp sell-off we experienced in 2011, such an occurrence would likely lead to aggressive asset allocation changes that include high cash levels, shorts, and options plays to hedge existing positions. The majority of investors often get sucked into these traps at the low, and then subsequently miss out on future price appreciation opportunities.
Additionally, don't count out the potential for another extension higher, despite all evidence to the contrary. Just because the market is overdue for a correction does not mean that one will materialize in perfect order to suit your entry points. Markets can often stay irrational much longer than we can stay solvent, which means you have to trade the opportunities that arise from careful research and investment discipline.
Action steps to cure your boredom
If you have a healthy dose of cash on the sidelines, I think it makes sense to build out your watch list and look to average into new positions or add to core holdings on weakness. Additional volatility this year should be used to your advantage by purchasing dips of sectors or stocks that have favorable price trends. Buying short-term weakness when the larger technical picture is still intact can improve your chances of a successful investment.
The Health Care Select Sector SPDR ETF (NYSEARCA:XLV) is one area I have my eye on for inclusion in my portfolio. Several of the underlying holdings, particularly in the biotech industry, are still well below their recent highs, and I believe the fundamental factors supporting the healthcare theme are sound.
You should also be reviewing existing positions to determine where there may be a need for risk management tactics. I recommend that you have an exit point for every position in your portfolio as a function of prudent investment discipline in the event the market falls out of bed. Avoiding large losses can help you rapidly achieve your goals on a year-over-year basis. This is an easy thing to forget when it seems like the market is lulling you to sleep.
Take advantage of the complacency to build your game plan, stay balanced, and consider both sides of the trade. The boredom won't last forever, and when it ends, success favors the prepared.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: David Fabian, FMD Capital Management, and/or clients may hold positions in the ETFs and mutual funds mentioned above. The commentary does not constitute individualized investment advice. The opinions offered herein are not personalized recommendations to buy, sell, or hold securities.