Near-Term Ideas For A Challenging Market

by: Dimitry Smirnov

Although Wednesday's FOMC minutes received comparatively little attention compared to previous ones, a few subtle market movements may presage the movement of equities in the next month or two. After the minutes were released, US markets slightly popped, as did gold (see GLD). Then the markets resumed their gradual slip while gold tentatively held and may have finally de-correlated from the "risk-off" mentality.

Further credence to this is that gold was up during Asian market trading. Surprisingly, there is very little certainty regarding the possible Fed action. Probably the least amount of certainty since QE1 began. Ironically, this will lead to one certainty: volatility.

The basic premise for volatility is the conflicting signals between good and bad data reports. The bears will point to high unemployment in the US as well as the European circus titled "who's paying for the Greek busted debt". However, Europe aside, economic data has looked modest to positive in the past few months, including rising housing starts, decent manufacturing reports and more recently, a drop in gasoline costs. Under the assumption that we can expect volatility, I suggest a few ideas for the near-term:

1) Keep shorting those bad stocks. Perhaps it's too late with Radio Shack (NYSE:RSH), but Best Buy (NYSE:BBY) and Sears (NASDAQ:SHLD) seem to be strongly biased towards the downside. You can expect an upward hiccup every now and then, but 20-30% of further price depreciation is easily possible, especially given a non-favorable environment. More recently, I would also add Molycorp (MCP) to the list as it strongly gapped down from long-term support levels. For MCP, there may be a day when it is a 10-bagger. But that's not today.

2) Long-term bonds & dollar. The TLT ETF tracks the price and yield of 20-year treasury bonds. It has been in a narrow channel for the past 7-months and is somewhat negatively correlated with stock market movement. The idea is to short TLT or buy in-the-money puts when equities fall and buy it when equities make any kind of top. Equivalently, the dollar has been a safe-haven as of late. A similar strategy can be applied with it, using the UUP ETF. We are not talking big gains here, but it's a good hedge against equities and may provide a few % gain over relatively short periods.

3) Gold. This is less certain than the top two points, but provided gold (GLD) can 1) stray from following the movement of equities' and 2) hold its current levels near $1550 an ounce, this would signal a change in sentiment where there is fundamental support instead of speculation. This would present an excellent buying opportunity with an added gift in case QE3 comes to fruition. If QE3 does not come about, there is less certainty here and the support level becomes key.

In summary, look for choppy waters in the near to medium term, possibly lasting through the US presidential elections. If markets get stuck going sideways, opportunities will abound for those who spot the support and resistance levels fastest.

Disclosure: I am short BBY.