Trading has become rather tricky nowadays, as markets move more with political headlines out of Brussels or Washington than with economic fundamentals. Last week is a case in point. News on the economy was much better than expected but it failed to excite the bulls, as they were focusing more on Italian and Spanish bond yields and the SuperCommittee deliberations than on U.S. economic indicators.
There comes a time, however, when markets have discounted the worst of news, and are ready for a rebound. That time may be very near, as short of a euro collapse, markets have discounted the European crisis. Markets have further discounted any scenario out of the SuperCommittee on the 23rd; and they may be helped by tailwinds from end of the year window-dressing and the “January Effect,” as we discussed in a previous piece. So, how should investors trade the coming relief rally?
1. Buy badly beaten cyclical stocks. For more than three months, cyclical stocks have been out of favor, including companies that reported decent earnings like Ford (F) and Caterpillar (CAT). The same is true for some materials producers like Freeport-McMoRan Copper and Gold (FCX).
2. Buy technology companies with solid fundamentals like Apple (AAPL), which has been unfairly punished, Cisco Systems (CSCO) and EMC that have been on the rebound, Hewlett Packard (HPQ) which has been drawing the attention of activist investors, and Qualcomm (QCOM) which has been benefiting from the surge in demand for mobile devices.
4. Stay away from U.S. Treasuries--and Treasury ETFs like TLT. Though a SuperCommittee scenario that reduces U.S. debt may benefit U.S. Treasuries, any gains may be limited, as yields are already near record low levels. Besides, money that will flow to stocks has to come out from somewhere.
A word of caution: The relief rally will be short-term-lived, as we still believe the world economy is heading for a recession. This means that our recommendations are for short-term investors. Long-term investors are better off staying on the sidelines or even building short positions as the rally unfolds.