Markets ended the week flat, with the Dow gaining a mere 0.26%. Top performers for the week were crude oil (+5.96%) and gold (+2.93%). The biggest losers were ten-year Treasuries, (-1.64%) and the U.S. dollar (-1.33%). It appears that the rally that began in early October may finally be weakening, and the market will give investors an opportunity to place additional cash to work at a more reasonable entry price point.
However, all things considered, 2012 is shaping up to be a positive year for the equity markets. Kevin Chupka’s Breakout article in Yahoo Finance highlighted that the Dow has only experienced 5 down years during Presidential re-election year, while gaining an average of 9%. Also, consumer confidence is up, the economy is adding jobs, and the U.S. is in the throes of an economic recovery. Issues that may negatively impact market performance continue to be Europe, the Middle East, and the U.S. deficit.
Looking ahead, here are the most important questions to consider: will the market experience up to a 5% correction, or will investors determine that equities are substantially overpriced and thus bring values down 10% or more? Many high-fliers are up well over 40% in less than six months. (My personal favorite is Apple, +45%). Assuming Europe and Iran remain stable, I am expecting up to a 5% pullback, which will act as a foundation to support the next leg of this bull market rally.
Investment sectors to consider as markets adjust include riskier ventures in oil and commodities, conservative plays in preferred stocks, and of course, traditional large-cap dividend payers. Positions that pay dividends typically generate better than average performance during pullbacks because as a security drops in price, the associated increase in dividend yield creates a resistance to downward pricing pressures.
Preferred stock ETFs to consider include the PowerShares Preferred Portfolio (PGX, three year return of 131%, dividend yield of 6.49%), iShares US Preferred Stock Index (PFF, three year return of 156%, dividend yield of 6.27%), and the PowerShares Financial Preferred Portfolio, which I personally hold (PGF, three year return of 191%, dividend yield of 6.93%). Preferred stocks do not mirror a growth fund’s performance, but they do offer a modest level of downside stability during market corrections. Additionally, you can’t beat a 6 to 7% dividend yield in an era when ten-year U.S. Treasuries have been paying less than 2%.
Problems in the Middle East and an improving U.S. economy have brought inflation back into play as housing prices have begun to stabilize. Oil inventories are at a ten-year high, but oil and gas prices have increased around 30% in the last three months. More importantly, we are far from the peak summer driving season, which will likely continue to drive prices higher. Other than implications related to global politics, local gasoline prices (which now range from around $3.50/gallon to over $5.00/gallon in California) are sensitive to the cost of state environmental control measures, distance from distribution centers, competition, and local taxes.
Positions to consider in energy include SPDR Select Energy Fund (EXL) and Conoco Philips (COP). More aggressive options include the iShares Oil and Gas Exploration Fund (IEO), the Barclays Crude Oil Total Return ETN (OIL), the United States Gasoline Fund (UGA), and the United States 12 Month Oil Fund (USL). I currently own both COP and IEO.
Escalating oil prices may provide investors with a focused near-term investment opportunity, but overall, higher oil prices will lead to destructive economic consequences on a global scale. As quoted in Jenifer Leigh Parker’s CNBC article, “Oil Above $120 Will Soon Hurt Stocks,” Erik Ristuben of Russell stated that the cost of oil has placed a cap on stock prices, and if prices remain high for three or more months, oil will certainly impact economic growth in the U.S.
Precious metals is another sector that typically performs well under inflationary pressure. For example, gold was up 3% silver was up 6.6% last week. I find silver to be too volatile, so I prefer SPDR Gold Trust (GLD), which I hold in my portfolio and have been recommending for several years.
Bottom line: expect a volatile couple of weeks. Take some profits and be prepared to add to equities as the market corrects. Other than gold and possibly energy, I would not add cash to equities until markets begin to pull back from current prices.