Investors with diversified portfolios should be in the phase of the year where they are evaluating their existing positions and looking to make strategic changes for 2016. This may include trimming under-performing holdings, doing some tax-efficient repositioning, or simply comparing performance versus a reasonable benchmark.
The Federal Reserve FOMC meeting this week will be a key factor in determining the outcome for many investors in 2016 as well. Overall, I want to caution against making any drastic changes to your portfolio in anticipation of this event. I think the risks are skewed to those who bet on a certain outcome, only to find that they are left unprepared for an unintended move in the market.
As I look through many charts of broad-based indices, I’m struck by how indecisive and trendless domestic stocks have been. This has been the result of a bifurcated sector dispersion that has created a tug of war in overall direction. The SPDR S&P 500 ETF (SPY) is virtually flat over the last 12-months and continues to navigate in a narrow channel.
If SPY can hold above $202, I view that as a positive sign that the stock market can hold things together in the near term.
There will likely be a great deal of intra-day volatility in SPY that accompanies any announcement by the Fed on Wednesday. Keep in mind that these fast moves should only be traded by those with short-term time horizons and aggressive risk management plans. For most investors, that means watching from the sidelines and evaluating the price action over the following days or weeks, rather than instantly trying to divine the next big move as headlines break.
Another key index to watch will be the PowerShares U.S. Dollar Bullish Index (UUP). The uptrend in the U.S. dollar that began in mid-2014 appears like it may be losing some steam in recent months. The convergence of the 50 and 200-day moving averages on the chart below also support this thesis.
The dollar has become less relevant as it has lost its upside momentum. However, a loss of confidence in the buck may lead to stymied growth in currency hedged ETFs that were so hot at the beginning of the year. The WisdomTree Europe Hedge Equity ETF (HEDJ) and Deutsche X-trackers MSCI EAFE Hedged Equity ETF (DBEF) still stand as the top two ETFs for year-to-date inflows, with a combined $27.9 billion in new assets.
That means investors are betting big that a rising dollar will boost their international stock performance. However, if this trade falters, we could see a big unwind in the Forex markets that puts downside pressure on UUP. This is certainly an index to keep on your radar screen.
Lastly, it’s time to turn to the all-important bond market. This is the obvious spot that investors are going to be watching in the coming weeks. Junk bonds have received a great deal of attention for their sharp drop and Treasuries will be scrutinized as a leading indicator of interest rate trends.
However, my eye is going to be on the investment grade corporate market. The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) has moderately under-performed this year, and its reaction to a rate hike will be telling for the stock market.
If investors continue to shun high quality corporate bonds, it may be a warning indicator that even the most liquid credit markets are tightening. This could put the damper on stock buybacks, corporate dividends, and additional bond issuance in the future.
Conversely, if this sector of the bond market is able to hold above its 2015 low, it may make for an attractive income opportunity. I’m particularly watching the shorter end of the investment grade credit spectrum, which should experience less interest rate volatility overall.
The bottom line is that as an investor, you should be cognizant of the historical trends in these asset classes and mindful of how the Fed’s decision will impact your existing portfolio.
As of this writing, David Fabian did not hold a position in any of the aforementioned securities.
