How To Prepare Your Portfolio For A Fed Policy Shift

by: BubbleBustInvesting

The Federal Reserve has been to accommodating for too long, keeping short-term interest rates at near zero levels for more than four years, and driving long-term rates to low digit levels with two rounds of QE. But judging from Chairman Bernanke's testimony in Congress today, this policy may be on hold, as the economy shows signs of improvement. Besides, with oil prices at record levels and the GDP deflator running ahead of expectations, the Chair takes a great heat from Congress and from bond vigilantes who may push long-term rates higher. This means that certain asset classes that have been soaring on the basis of ever-accommodating monetary policy may be ripe for a sharp correction. What should investors do?

Here are four trades they may want to consider:

1. Sell high-flying cyclical stocks. For more than two years, commodities had everything going their way. This is especially true for materials and precious metals: ultra-accommodating monetary and fiscal policy, a falling dollar, a growing world economy, inflationary expectations, and soaring sovereign debt. Walter Energy (NYSE:WLT) that missed on second quarter revenues by a great margin is up 400 percent since 2009. Cliffs Natural Resources (NYSE:CLF) is up 300 percent. iShares silver trust (NYSEARCA:SLV) is up 150 percent since early 2009; SPDR Gold Shares (NYSEARCA:GLD) is up 98 percent; and Freeport-McMoRan Copper and Gold (NYSE:FCX) soared 300 percent. But with rising long-term interest rates and the world economy sliding into recession the commodity rally is over; and may be succeed by a bear market.

2. Be Selective on Chinese stocks. A potential spike in U.S. interest rates will slow-down for Chinese products, and may even intensify trade tensions between the two countries. Besides, as we discussed in a previous article, buying Chinese companies traded in U.S. exchanges is a high-risk strategy, as these companies are subject to frequent changes in rules and regulations that undermine their ability to stay in business and maintain profitability. Smaller Chinese companies, especially those listed through "reverse mergers," are conducive to accounting fraud and manipulation. While I will stay with quality names Sina Corporation (NASDAQ:SINA), Baidu, Inc. (NASDAQ:BIDU), and Inc. (NASDAQ:SOHU) that had good earnings reports, I will stay away from, Inc. (NYSE:YOKU), E-Commerce China Dangdang (DANG), Renren Inc (RENN). and the likes that had missed earnings expectations.

3. 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 (NASDAQ:CIEN), JDS Uniphase Corp (JDSU), Corning, Inc. and Ariba Inc. (NASDAQ:ARBA). Now the theme is social media and web-based companies, like Open Table Inc. (NASDAQ:OPEN), and LinkedIn Corp (LNKD), and Apple (NASDAQ:AAPL) that has become a momentum stock lately. Momentum investing can be very rewarding as long as it lasts. But it can result in hefty losses once it fades away, especially for investors who got in at the top.

4. Stay away from U.S. Treasuries -- and Treasury ETFs like TLT. U.S. Treasuries are vulnerable to any slight uptick in interest rates, especially after their big run up in recent years.

Disclosure: I am long AAPL.