THE FED CONFOUNDS INVESTORS
Given the release from the Fed last week that they would hold rates low and continue Operation Twist more ,(they will never stop twisting by the way), I think it is more important than ever to review the Sector Rotation Model that I've posted in years past.
This model helps us review where we are and look at the industries and sectors we should be examining to purchase in anticipation of where we will be. Thanks as always to www.stockcharts.com, I recently became a member of their service and find it very helpful especially since I punted E-Trade Pro for good!
As we look at the overall economic environment it appears as though we are at a market top and we are entering a recession despite all of the attempts by the Fed to do something to stimulate the US. Based on the Sector Rotation Model we'd be getting ready to move from our consumer staples positions into healthcare and utilities and then ultimately into finance. However, we've been in these extremely profitable positions for almost a year and a half now, so something is amiss with the rotation model right? Even though the trade is a bit old, I still continue to expect that these same positions may not go higher, but on a relative basis will outperform..... (portfolio manager speak for keep your money in my fund!)
I would caution though, that the "normal" progression to go to finance and banks will be a deadly one. There are several key factors that will make this a bad move in the future. First, banks continue to hide and lie the embedded risks they have on balance sheets and the issues with Europeans sovereigns will only reveal these more of these problems. (I am speaking of the mega banks here). In addition, in a recession, you'd see normally that the Fed would step in and lower interest rates creating a stimulative environment for these institutions, but as we know, the Fed has no room to lower anything. Thus, banks will be dead money. Some might suggest that you'd buy preferred from some of these institutions, I'd say, "Why Risk It?
MORE OF THE SAME
So to quickly wrap up this macro-perspective, we need to stick with more of the same here. More defense (PPA), more healthcare (XLV), and more utilities (XLU). Don't get too ahead of yourself thinking that the coming recession can be avoided as we are in the wasteland created by ZIRP, courtesy of the Fed and there is no stimulus that can be provided that will be lasting.
RISKS ON THE HORIZON
What could jeopardize our strategy? Simply put, the tax on dividends created by the expiration of the Bush tax cuts. Ultimately if dividends are taxed at any higher rate and Congress doesn't do anything to address this, there could be a move to sell many of the significant winners that investors have benefited from over the last couple of years. What caused this great surge in dividend paying stocks? The Fed of course! As rates have been crushed lower, investors has fled from bonds into dividend paying stocks as a proxy income tool. It would seem like any tax hike could usher in a wave of selling to avoid the new revenue grab by our wonderful government.
GIVE UP ON GOLD, SILVER, AND OTHER COMMODITIES?
I'll leave you one last thought, despite the slow down here, is this rotation suggesting that gold, silver, and other commodities are done. Yes.....and no. We'll talk more about how even though the model suggests that these commodities would be the worst place to be, they just might be in the sweet spot. Look for that post later this week.