If you’re a trader — i.e., if you are active with your portfolio and buy and sell stock or ETFs in pursuit of alpha — then the wild gyrations in the market during the first three months of 2014 were likely very interesting.
If you were long stocks in January, you probably underperformed. If you were short stocks in February, then you also likely underperformed. Of course, those savvy enough to be on the opposite side of those trends did well during those respective months. If you were active in March … well, your results probably bounced around all over the place regardless of your bias.
This year, the climate for traders has been far tougher than it has been in the past couple years. Let’s face it; if you had a generally bullish bias in stocks in 2012 and 2013, you probably did pretty well. So far this year, however, that same bias hasn’t worked as well.
In fact, the market in 2014 is more of what I call a “market of stocks,” rather than a “stock market,” meaning that you can’t just go long and expect to make money big money. We should continue to see this market of stocks in the second quarter, which means that when making trades, you need to focus in on short- and medium-term trends likely to continue over the next three months.
So, which trades are likely to give you some nice performance in Q2? Here are three of my favorites to kick off the second quarter:
Q2 Trades to Make #1: China Rebound (FXI)
Click to Enlarge There has been a lot of negative chatter in 2014 regarding China. Concerns over the country’s economic growth as well as its shadow banking system have prompted a lot of money to exit Chinese stocks this year.
In fact, from the beginning of the year through its recent low on March 13, stocks in the iShares China Large-Cap (FXI) were down more than 11%. FXI still is one of the worst-performing ETFs in the market for Q1, but since that March 13 low, stocks in FXI have seen a marked comeback, vaulting more than 8% through March 28.
The big catalysts for the buying in FXI are 1) a perception that Chinese stocks just became way too oversold, way too fast, and 2) that China has hinted it would make the necessary monetary adjustments to infuse capital into the country’s financial system (e.g., through various forms of monetary stimulus), that would keep the financial wheels greased and money flowing into the economy and stock market.
Essentially, getting long FXI for a Q2 trade is a great way to take advantage of what I think will be a continued bounce in China fueled by fast money.
Q2 Trades to Make #2: Short Bonds
Click to Enlarge When the Fed speaks, Wall Street listens … and as a trader you need to do the same.
New Federal Reserve Chair Janet Yellen recently made a comment in her March 19 post-FOMC presser saying that she thinks interest rates would start to rise sometime around six months after the end of quantitative easing.
That statement didn’t really come as much of a surprise to me, especially considering that 10 of the 16 Fed officials wrote that they believed the Fed Funds rate would be at or above 1% by the end of 2015. That’s an increase in the Fed’s bias from December, when only seven Fed officials thought the Feds Fund rate would be higher by next year.
The bottom line here is that most big Wall Street traders know that bond yields are going to rise this year, and that means bond prices are going to falter. If this trend starts to ramp up in the second quarter, you’ll want to be short bonds with some of your trading capital.
The best way to do that is to own the ProShares UltraShort 20+ Year Treasury (TBT), an exchange-traded fund that gives you twice the inverse of the daily performance of the Barclays U.S. 20+ Year Treasury Bond Index.
So, if long-term Treasury bond prices fall 2%, then TBT is designed to rise 4%. Just keep in mind that inverse and leveraged funds don’t always perfectly track, plus you have to factor in expenses, so the result isn’t going to be a perfect one-for-one (or two-for-one).
Q2 Trades to Make #3: Small Caps (IWM/UWM)
Click to Enlarge If your outlook for the next several months is bullish, then you’ll want to make sure you have some broad-based exposure to the market. This exposure should not, however, be in lumbering market segments such as the Dow or S&P 500.
Certainly, if you’re a bullish long-term investor you should have exposure to these market barometers … but for your trading capital you’ll want to get more aggressive with your bullish bet.
One way I like to take advantage of a bullish short-term trend in the market is via the traditionally faster-moving small-cap segment of the market, and that means trading an ETF pegged to an index such as the small-cap Russell 2000.
The way I see it, there are two routes you can go here. You can buy the iShares Russell 2000 (IWM), an ETF that mirrors the performance of its namesake index. Or, you can get more aggressive (my preferred way) by using a leveraged version of the index such as the ProShares Ultra Russell 2000 (UWM). The levered version allows you to theoretically capture twice the performance of the index, so if the Russell 2000 jumps 5% during Q2, your holding should be up 10%.
As of this writing, Jim Woods did not hold a position in any of the aforementioned securities.
