For stocks, deja vu all over again?
By David K. Randall
(Reuters) – Market history may be repeating itself.
Through Monday, the Standard & Poor’s 500 stock index was up 9.0 percent for the year to date, thanks in large part to signs that the U.S. jobs market and retail sales were improving. It’s a performance nearly identical to last year, in which the S&P 500 index jumped 8.4 percent between the first of the year and its high in April.
Some analysts are beginning to worry that 2012 will follow the same pattern.
“Make no mistake, there’s no way this year will continue to go smoothly,” said Andrew Goldberg, global market strategist for J.P. Morgan Funds.
It’s tempting to simply move money to cash or short-term Treasury bonds whenever there is a hint that the market rally is peaking. But there are better ways to protect a portfolio from a sustained slide without giving up the chance for future gains.
Here are suggestions on how to play a possible repeat of 2011.
PREVENT A PULLBACK
Last year, spiking oil prices from the revolutions in the Middle East, a slowdown in the global economy from Japan’s massive earthquake and tsunami, and political flare-ups in Washington resulting in a credit rating downgrade, all sent the S&P 500 index sliding. A rally that began in October helped the S&P 500 eke out only a 2.0 percent gain for the year, after dividends.
Goldberg worries about a repeat of last year’s volatility with nagging problems such as Europe’s sovereign debt crisis and another spike in oil prices on talk of an armed conflict between Iran and Israel. The U.S. is also is facing a steep cutback in government spending at the end of the year that could make the economic growth stall, he said.
Some money managers are now turning to the options market as a way to lock in profits.
Tyler Vernon, chief investment officer at Princeton, New Jersey-based Biltmore Capital Advisors, is increasingly opting for covered call options to protect his clients’ assets from a market pullback. These options allow an investor to sell a contract that would obligate them to sell a stock at a given price at a designated future date, in exchange for an upfront payment. Investors who sell covered calls continue to hold on to their positions and collect stock dividends in meantime.
Vernon is selling January 2013 contracts that allow investors to sell shares of Caterpillar at a price of $110. The income from each covered call he sells is $9.50 per share, he said.
“The real risk here is the upside is capped. But most of my clients say that they are willing to get a nice premium payment up front and continue to get dividends when they don’t think that this position could go up another 5 to 10 percent,” he said.
Vernon is also turning toward mutual funds that take both long and short positions in funds, a tactic that he says is cheaper than investing money in a traditional hedge fund. He likes the Marketfield fund, a $1.3 billion fund that charges $1.56 per $100 invested.
The fund owns 55 long stock positions and 16 short positions, and is shorting emerging markets and China through ETFs, according to Morningstar data.
“Timing is the major risk in this fund’s strategy,” wrote Josh Charney, a fund analyst at Morningstar, in a research report.
Marketfield is up 5.3 percent for the year to date and 8.9 percent over the last 12 months, according to Morningstar. Its largest long position is a stake in industrial supplier W.W. Grainger shares are up nearly 14 percent so far in 2012, and they yield 1.2 percent.
Sam Stovall, chief equity strategist at S&P Capital IQ, thinks that now might be the time to shift dollars into classic defensive sectors like healthcare and consumer staples.
He has history on his side. Since 1990, rotating into these defensive sectors in May and then moving back into the broad S&P 500 index in October produced an annual return of 10.7 percent, he said. Investors who stayed in the broad S&P 500 index the whole time notched returns of 6.7 percent, he noted.
“There’s the old Wall Street saying of ‘sell in May and go away.’ This might be a year in which you might want to take that saying literally,” he said.
ETFs might be the easiest way to do this. The $989 million Vanguard Consumer Staples ETF, for instance, charges 19 cents per $100 invested and yields 2.2 percent. Its top holdings are Procter & Gamble Co, Coca-Cola Co and Philip Morris International Inc.
The fund is up 6 percent this year, as of Friday’s close, and gained 13.6 percent in 2011 despite the broad market’s small gains.
Stovall said that there also might be a technical-trading case for moving into defensive stocks. S&P’s technical trading analysts expect the S&P 500 to follow a similar pattern to last year: falling to about 1340, regaining some of its losses, and then suffering a more pronounced decline.
Bill Stone, chief investment strategist at PNC Asset Management Group, is looking toward technology companies as a hedge against another market pullback like in 2012.
“Technology on the surface doesn’t appear to be defensive, but it happens to have companies with low payout ratios, high amounts of cash, and little amounts of debt,” he said. He expects more companies to follow Apple’s lead and either initiate or increase their cash dividends.
The Technology Select SPDR is one option. The $9.3 billion fund costs 18 cents per $100 invested and yields 1.3 percent. The fund has nearly 20 percent of its assets in Apple Inc. International Business Machines Corp, Microsoft Corp and AT&T Inc round out its top holdings.
(Reporting By David Randall; Editing by Walden Siew)