The brutal selling of last week and Monday, and the crazy volatility of this whole week so far, has every market watcher scrambling to figure out when this selling will stop.
Perhaps more importantly, traders, advisors and pundits are trying to best figure out how and when to buy this market volatility. The No. 1 question I’ve been getting from financial advisors that subscribe to The 7:00’s Report is: “How do we buy this market volatility?”
The general consensus is that the latest round of selling was due to combined global slowdown fears coming out of China, Federal Reserve uncertainty over the first interest rate hike in nearly a decade, and an oil-led commodities collapse.
Given those major market drivers, I think there are five key things that must happen for this selling to stop — and to give investors the green light to buy this market volatility.
- Markets need to see competence from Chinese authorities. More so than the actual economic data, it’s the loss of the perception that Chinese authorities know what they are doing that’s fueled this spread of China-related angst. Partly sparking Monday’s rout was the fact we heard nothing from Chinese authorities over the weekend, which (rightly or not) reinforces the idea they are clueless right now — and that won’t make the selling stop. On Tuesday, we did see some signs Chinese policymakers know which end is up, as they announced they were cutting one-year lending rates, and more importantly, dropping reserve requirements. These steps alone won’t solve the developing confidence problem with Chinese authorities, but it is a positive step — and the first step to a bottom in stocks.
- Economic data needs to stabilize in China. For things to really stabilize in global markets, we need to see China’s economic data improve. Unfortunately, we won’t get any details on this front until Aug. 8, when we get the August trade balance data.
- The Fed needs to get it together. Confidence in policymakers is a key ingredient for this market. If we want to see this selling stop, we are going to need the Fed to get on one page and stop letting the market view the indecisiveness in real time. Unfortunately, that’s not happening right now. Today, New York Fed President William Dudley said that a rate hike in September seemed “less compelling.” Next, we’ll have to wait for Fed Vice Chair Stanley Fischer, who will speak Saturday at the Jackson Hole Central Bank conference. Fischer needs to project confidence and certainty in the Fed’s outlook and strategy for this market to settle, and for us to buy this market volatility.
- U.S. economic data needs to stay decent and refute this growing perception that China is outsourcing the next great financial crisis. The next major U.S. economic data point is the August employment report on Sept. 3. If the jobs picture disappoints, this market won’t get the stability it so desperately needs.
- Oil prices need to bottom. Oil forecast this decline, and it needs to bottom before stocks can stabilize, and before we can see this selling really stop. While there are signs of fundamentals turning in oil, a real change in the supply/demand metrics are anything but imminent. Until oil settles, a bottom in stocks is not likely.
A “One-Fifth” Strategy
Although we are far from being able to declare a bottom in stocks, there are some longer-term values we want to take advantage of, and for those with cash on the sidelines burning a hole in their portfolio pockets, here is one responsible way to do just that.
I call this my “one-fifth” strategy.
Each time one of the five key things needed for a bottom to be achieved actually happens, you put one-fifth of your cash to work in the sector or asset of your choosing.
For example, on Tuesday, Chinese authorities did something to restore some confidence, so in my personal account I allocated about one-fifth of the cash I want to put to work into the market. When a second item off our “key things” list happens, I’ll put another fifth or so of that cash to work, and so on.
Obviously, doing this means the allocation will take several weeks (if not much longer) before you can put a significant amount of cash to work, as not all of the five things can be achieved before early September.
The bottom line here, however, is that this measured one-fifth approach is a responsible way to buying this market volatility.
But What Do You Buy?
Of course, knowing what to buy here is no easy task, but having a one-fifth strategy isn’t much good without at least a few sound ideas of where to put that cash. Toward that end, I have a couple of key sector ideas I’ve been recommending to The 7:00’s Report subscribers.
First, all of this macro volatility has resulted in some consumer cyclical stock underperformance, but the thesis behind cyclical outperformance going forward is still valid.
Here I like retail stocks, such as those found in the SPDR S&P Retail ETF (XRT). Stellar performers such as Amazon (AMZN) and Netflix (NFLX) are big components of XRT.
I also like small-cap growth stocks here, as they are likely to benefit if we see a stabilization of economic growth, and decisive Fed action. Stocks such as those in the iShares Russell 2000 Growth ETF (IWO) represent a good place to put some of the cash using your one-fifth strategy.
Tom Essaye is Editor of The 7:00’s Report, a daily “cheat sheet” on the markets that’s delivered by 7 a.m. and readable in 7 minutes.
