For more than three years, traders have focused on three trades: Buy commodities (mostly precious metals), buy US treasuries, and buy non-cyclical stocks, especially those paying hefty dividends. The reasoning behind these trades was an ever accommodating Fed determined to drive every single interest rate down to zero, trashing the dollar in the process. In the meantime, traders avoided certain domestic sectors, like home builders, believing that the housing market will never recover.
Everyone who follows the US economy closely lately, especially the dramatic improvements in the employment picture, understands that many of these assumptions are off the table. This means that it is about time to change trading strategy. Here are four types of trades to consider:
1. Buy Homebuilders. A good employment report is very bullish for homebuilders, as it increases the likelihood of people buying homes. Besides, economic fundamentals for the industry have been improving: New home inventories are declining; homebuilder confidence is improving; home prices are stabilizing; and industry leaders like Toll Brothers (TOL) have been reporting better-than-expected earnings results. Conservative investors may want to buy an ETF investing in homebuilder stocks like SPDR Homebuilders (XHB) and Ishares Dow Jones Home Builders (ITB), or buy the shares of diverse homebuilders like D.R.Horton (DHI). Aggressive investors may want to accumulate the shares of individual homebuilders that have been taking steps to address the housing crisis early, like Lennar Corporation (LEN), Toll Brothers, Standard Pacific (SPF), and Honvanian Enterprise (HOV) - though due diligence is recommended.
2. Buy Cyclical Stocks. An improving job picture is good news for cyclical stocks like Ford (F), General Motors (GM), Toyota Motor Company (TM), and Honda Motor Company (HMC), Nike (NKE) and Coach (COH).
3. Avoid High-flying energy Materials and Precious Metals. A strong employment report diminishes the prospect of further QE by the Fed. This is certainly bad news for high-fliers in the materials and energy space like Walter Energy (WLT), Cliffs Natural Resources (CLF), Oil Service Holders (OIH), Ishares silver trust (SLV), SPDR Gold Shares (GLD) (up 100 percent) and Freeport-McMoRan Copper and Gold (FCX).
4. Avoid non-cyclical stocks. These stocks fare better during a declining rather than expanding economy like big pharma stocks - Pfizer (PFE), Bristol-Myers Squibb (BMY), Abbott Laboratories (ABT), Eli Lilly (LLY) and Merck (MRK) - that enjoy hefty profit margins, ranging from 19% to 32%; and pay hefty dividends, ranging from 3.80% to 5.5%, compared with 1.88% for S&P 500 stocks (SPY).
Additional disclosure: Active trader. May change positions at any time