The word of the financial day is “boring.” We’ve entered a phase of miniscule price movements, low-volume metrics, a multiyear low in volatility, and uncertain economic data.
In short, stocks are boring us to death one slow day at a time.
The problem is compounded by the fact that the SPDR S&P 500 ETF (SPY) is sitting close to all-time highs and defied nearly every “top” that experts have predicted. This has many traders sitting on their hands or frustrated with the lack of movement in existing positions. No one wants to add up here, but no one wants to short this resilient market, either. This problem will only be settled through time and price.
Months of choppy action in equities have resolved in SPY gaining a modest 5% on the year. However, the underlying sector movement has shown a much different story. The Consumer Discretionary SPDR (XLY) is sitting in negative territory and clinging to life support with Q1 GDP showing its first negative print in years. On the other side of the spectrum, the Utilities SPDR (XLU) has gained more than 14% this year on the back of falling interest rates and defensive repositioning.
The most recent data on the CBOE Volatility Index (VIX) shows a reading under 12, which translates to a lack of fear and general complacency in the market. In addition, investor sentiment readings continue to show the majority of investors in a neutral stance (i.e. lacking a bullish or bearish conviction to gain an edge).
Everyone appears to be waiting for the next shoe to drop, but while stifling a yawn and looking over their holdings.
So … Where Do We Go From Here?
Most active investors are trying to divine what the next big move will be. After months of rallying in tandem, stocks and bonds are at the top end of their range and are starting to show some signs of indecision. The two most likely scenarios of course are:
- Stocks continue higher with a selloff in bonds, or…
- The much-anticipated equity correction materializes this summer and interest rates fade alongside them. This would be supportive of bond prices with the exception of credit-sensitive holdings.
While there is an outside chance we will see additional positive correlations in both stocks and bonds, I believe we are overdue for a divergence that lends itself to a more traditional balance between the two asset classes.
In the very near term, I would not be surprised if SPY dipped back down to retest its 50-day moving average and provide an additional layer of intrigue for bulls and bears.
The one thing that might catch the majority of participants off guard right now would be a severe drop in stocks that ratchets up volatility, volume and risk. Similar to the sharp selloff we experienced in 2011, such an occurrence would likely lead to aggressive asset allocation changes that include high cash levels, shorts and options plays to hedge existing positions. Most investors often get sucked into these traps at the low, then subsequently miss out on future price appreciation opportunities.
Additionally, don’t count out the potential for another extension higher despite all evidence to the contrary. Just because the market is overdue for a correction doesn’t mean one will materialize to suit your entry points.
Markets can often stay irrational much longer than we can stay solvent, which means you have to trade the opportunities that arise (using careful research and investment discipline, of course).
How to Cure Your Boredom
If you have a healthy dose of cash on the sidelines, build out your watch list and look to average into new positions or add to core holdings on weakness. Additional volatility this year should be used to your advantage by purchasing dips of sectors or stocks that have favorable price trends. Buying short-term weakness when the larger technical picture is still intact can improve your chances of a successful investment.
The Health Care SPDR (XLV) is one area I have my eye on for inclusion in my portfolio. Several of the underlying holdings — particularly in the biotech industry — are still well below their recent highs, and I believe the fundamental factors supporting the health care theme are sound.
You also should review existing positions to determine where you need to practice a little risk management. I recommend that you have an exit point for every position in your portfolio in the event the market falls out of bed. Avoiding large losses can help you rapidly achieve your goals — but it’s easy to forget that when the market lulls you to sleep.
Take advantage of the complacency to build your game plan, stay balanced, and consider both sides of the trade. The boredom won’t last forever, and when it ends, success favors the prepared.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Learn More: Why I love ETFs, And You Should Too