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How To Prepare For Volatile Markets

The last few years have been a relatively calm period for the US stock market, with few of the large swings that characterized markets during the financial crisis and the subsequent few years. But if the start of this year is any indication, 2016 may be more turbulent. What should you do with your investments to protect yourself from that possibility? The answer might actually be “nothing.” The first few days of a year don’t necessarily predict how the rest of the year will turn out. And larger market moves don’t necessarily mean you should make any changes to your portfolio. Markets go up and down all the time, and taking no risk with your investments would mean you wouldn’t have the chance to achieve more than meager returns. But if you are worried about market volatility, there are a number of ways to try to combat it, some more advisable than others. One way to try to protect yourself is to directly bet on volatility so that you’ll profit if markets become more tumultuous. These types of bets typically involve complex financial products such as options or exchange-traded products based on an index of stock market volatility. While betting on volatility can work in the short term if you guess correctly, it’s generally a terrible long-term strategy. For example, the iPath S&P 500 VIX Short-Term Futures ETN (NYSEARCA: VXX ), one of the exchange-traded products tied to volatility, has lost more than 99% of its value since early 2009. Unless you fully understand how these types of products work and the unique risks involved, betting directly on volatility probably isn’t a good idea. A second way to try to counteract stormy markets is to shift some of your stock allocation into “low-volatility” funds. These investment products have proliferated in recent years and hold stocks that historically have had been less volatile. These funds can indeed help reduce the impact of choppy markets, but there’s no guarantee that the stocks that historically bounced around less will outperform during any one future period of stock market instability. It’s also worth considering that some of these funds may shift your exposure not just toward less-volatile individual stocks, but also more broadly to less-volatile market sectors (such as utilities). Changing your sector exposure isn’t necessarily good or bad, but it’s something to be aware of if you’re thinking about low-volatility funds. Perhaps the simplest way to prepare for market turbulence is simply to shift some of your allocation in higher-risk investments (such as stocks) into lower-risk investments (such as bonds). Shifting your allocation doesn’t mean completely abandoning stocks – you don’t want to make it impossible to achieve your financial goals if stocks actually perform well – but rather, making slight adjustments so that you’re more comfortable with how your portfolio is positioned. After all, if the possibility of more volatile markets is keeping you awake at night, that might be a sign that your portfolio isn’t properly calibrated to your risk tolerance.

6 ETFs To Play In Q1

The year 2016 unfolded amid a myriad of woes and huge uncertainty. The woes stemmed mainly from the developed foreign economies due to growth issues and uncertainties in the homeland emanating from the speculation over the speed and quantum of the Fed rate hike throughout 2016. The Fed enacted a meager hike at the tail end of 2015 and as of now, the investing world is expecting four more hikes in 2016, if everything goes well. However, things could change any point of time along with global or domestic market occurrences (read: ETF Tactics for a Rate-Proof Portfolio ). The broader global indices were mostly in red in 2015 snapping the bull market trend seen in earlier years. Now, all eyes will be on how the year 2016 fares on the bourses. Let’s not move too further ahead and instead focus on the prospective ETF winners of the first quarter of 2016. To do this, we have relied on both seasonality of the asset class and the earnings performance of the equity sectors. iShares U.S. Financials ETF (NYSEARCA: IYF ) The operating environment for financial companies is presently benign thanks to the Fed liftoff. In a rising rate environment, financial companies’ net interest margin should also rise. In any case, U.S. banks are in a better shape right now (read: Guide to the 7 Most Popular Financial ETFs ). Finance is expected to be a growth driver in the fourth-quarter 2015 earnings season which is already underway. The sector is expected to score the second-best earnings growth of 6.8%. Finally, as per Equity Clock, the financial sector, especially the banks, enjoy seasonality in the first quarter of every year. iShares Transportation Average ETF (NYSEARCA: IYT ) Equity Clock also reveals that the first quarter is beneficial for airlines and railroads with seasonality kicking in from the end of January and extending till early May. Plus, stepped-up economic activities and cheap fuel are still there to drive up transportation stocks. The transportation sector is expected to report 12.1% growth in earnings on just a 1% decline in revenues. One way to play this trend is with IYT. The ETF tracks the Dow Jones Transportation Average Index, giving investors exposure to a small basket of close to 25 securities. Utilities Select Sector SPDR ETF (NYSEARCA: XLU ) Gas utilities are normally in demand in the cold-stricken first quarter. Though utilities are likely to be on the downside following the Fed liftoff, but no material hike in the long-term interest rates since then made the sector a winner last one month compared with several glamorous and in-vogue sector ETFs like the Consumer Discretionary Select Sector SPDR ETF (NYSEARCA: XLY ) and the Technology Select Sector SPDR ETF (NYSEARCA: XLK ) . The fund added 0.3% in the last one month (as of December 31, 2015) while XLY and XLK were down over 4.2% and 3.4%, respectively, during the same timeframe. Market Vectors Retail ETF (NYSEARCA: RTH ) According to Equity Clock , seasonal strength for the consumer discretionary sector stretches from October 17 to April 12. The sector is expected to post earnings growth of 2.4% in Q4, much better than the consumer discretionary sector’s expected earnings decline of 4.8%. Its sales expectation is also steady at 6.4% for Q4, again better than 1.4% growth expected from the consumer discretionary space. More jobs and cheaper fuel should help these sectors to grow. PowerShares DB USD Bull ETF (NYSEARCA: UUP ) The greenback is yet another asset which enjoys the tailwind of seasonality in the first quarter, per analysts. In any case, this U.S. dollar ETF lost over 1.2% in the last one month (as of December 31, 2015) giving the product a leeway for rally. The key logic behind the ascent as per Investopedia is that investors must have repatriated money at the yearend, resulting in a weaker dollar and then again bet on the dollar in the New Year. Also, in 2016, the U.S. dollar should have one more reason – U.S. policy tightening – to celebrate. iShares Russell 2000 ETF (NYSEARCA: IWM ) Small-cap stocks are the barometer of domestic economic health. So, when the U.S. economy shifted gear in December and experienced policy normalization, most eyes moved to small-cap stocks in order to cash in on the U.S. economic growth momentum. Plus, Russell 2000 has a history of rallying in January and February, as per Equity Clock. In any case, if dollar gains strength, investors will definitely bet on small-cap stocks as larger caps are more vulnerable to the dollar strength. Link to the original article on Zacks.com

Recommended Stock And Bond ETF/Fund Choices For Best Future Gains

Stocks May Be a Slightly Better Bet in 2016 In my July 2, 2015 article on Seeking Alpha, I presented my then up-to-date Model Portfolio for Stock ETFs/funds. In this article, I will update my recommendations and include my latest Model Portfolio for Bonds along with my overall asset allocations. In spite of the perils of forecasting, I am raising my quarterly overall allocation to stocks, but just a tad. The main reason is merely because, although I don’t anticipate much better returns for stocks in 2016 than in 2015, using a 3 to 5 year horizon (my target range), stocks present a more favorable outlook than for bonds, and certainly, than for cash. The ongoing trend one-year trend for stocks, something I watch carefully, is now negative. While one year’s returns likely don’t show much of relationship to the following year’s performance, the high returns observed between 2009 and 2014 have led to a highly priced market. As a result, future returns are more likely, in my opinion, to be somewhat subdued. Here are my overall allocation recommendations, as subdivided into 3 rough categories based on one’s self-estimated tolerance for risk. For Moderate Risk Investors Asset Current (Last Qtr.) Stocks 52.5% (50%) Bonds 35 (35) Cash 12.5 (15) For Aggressive Risk Investors Asset Current (Last Qtr.) Stocks 67.5% (65%) Bonds 22.5 (22.5) Cash 10 (12.5) For Conservative Investors Asset Current (Last Qtr.) Stocks 20% (15%) Bonds 50 (50) Cash 30 (35) January 2016 Model Stock Fund Portfolio Value vs. Growth Categories Okay, fans of Large Growth funds, you’ve been consistently beating Large Value funds when looking at annualized past five year returns every January going all the back to Jan. 2010. That’s quite a string. This means if you over weighted the average Large Growth fund as early as Jan. 2005 and held that over weighted position throughout, your returns would have exceeded the average Large Value fund by about 2% each year, and the average of all U.S. diversified categories of funds by about 1% a year. What gives, and can the streak continue? Large Growth funds tend to contain heavy doses of Technology stocks as well as Consumer Cyclical stocks. Large Value funds are particularly attracted to Financial Services stocks, with more of a commitment toward Energy and Utility stocks. Both Technology and Consumer Cyclical have done quite well over the last 10 years, Utilities, Energy, and especially Financials, have not. As you probably are aware, Energy stocks have done particularly poorly over the last two years, while Financials took a particularly severe beating during the 2007-08 financial crisis and have been much slower to recover strongly since then compared to stocks as a whole. I have been overweighing Large Value over Large Growth for several years now which, up to now, hasn’t paid off. While both categories have done well, the average Large Growth fund has beaten the average Large Value fund by about 4% annually over the last 3 years. But, according to my proprietary research, while both categories should do adequately in the years ahead, Large Growth still comes out a little better on my list of most recommended US stock categories. The biggest question mark for value funds appears to be whether financial stocks, often their biggest component, can bounce off a relatively underperforming 2015, not to mention whether energy and utility stocks held in lesser amounts, can get back to anywhere near positive returns. In light of the continuing somewhat iffy prospects for Large Value funds, I am dropping my recommended allocation to 17.5% from 20%. Instead, I recommend putting the freed-up money into the Fidelity Contra Fund (MUTF: FCNTX ). I am also dropping my allocation to the Vanguard Financials ETF (NYSEARCA: VFH ) since our Large Value holdings already cover this sector. International Stock Funds Given the stronger prospects for most international funds as compared to U.S. stocks (described in my recent Jan. 2016 Seeking Alpha article “Best Stock ETF/Fund Categories For Future Gains”), I suggest a bumped up allocation to the former. U.S. stock funds, on average, have performed considerably better than international ones going back as far as 10 years. So, it might appear that I am running the risk of acting “prematurely” by going to an even higher international recommendation than before. This is always the chance one takes when one starts to favor underperforming categories under the assumption that they are “due” to turn things around. But my research suggests that more frequently than not, it is usually more important to recognize potential undervaluation in a category than to always wait for strong positive momentum trends before investing. Thus, while emerging market stocks currently have strong negative momentum, my research suggests that they offer among the best prospects for longer-term investors (along with some badly beaten up sector funds), but both mainly for Aggressive investors. It is interesting to note that stock markets in the Euro zone had a much better year in 2015 than US stock markets with a main index of European stocks up about 8%. However, for US investors, the increase in the value of the dollar vs. the Euro resulted in much of those gains being wiped away, unless you were invested in a European fund that hedges its currency exposure, such as the WisdomTree Europe Hedged Equity ETF ( HEDJ) mentioned below. Our Specific Fund and Allocation Recommendations Now (vs Last Qtr.) Fund Category Recommended Category Weighting Now (vs Last Qtr.) Fidelity Low Priced Stock Fund (MUTF: FLPSX ) 10% (12.5%) Mid-Cap/ Small Cap 10% (12.5%) Fidelity Overseas Fund (MUTF: FOSFX ) 5 (0) (New!) Vanguard Europe Index Fund (MUTF: VEURX ) 5 (10) Vanguard Pacific Index Fund (MUTF: VPACX ) 10 (10) Tweedy, Browne Global Value Fund (MUTF: TBGVX ) 5 (5) Vanguard Emerging Markets Stock Index Fund (MUTF: VEIEX ) 10 (7.5) DFA International Small Cap Value Portfolio (MUTF: DISVX ) 5 (2.5) (See Notes 1, 2 and 3.) International 40 (35) Fidelity Large Cap Stock Fund (MUTF: FLCSX ) 7.5 (7.5) Vanguard 500 Index Fund (MUTF: VFINX ) 7.5 (7.5) Large Blend 15 (15) Vanguard Growth Index Fund (MUTF: VIGRX ) 7.5 (7.5) Fidelity Contra 7.5 (5) Large Growth 15 (12.5) T. Rowe Price Value Fund (MUTF: TRVLX ) 5 (7.5) Vanguard Equity Income Fund (MUTF: VEIPX ) 7.5 (0) (New!) Vanguard U.S. Value Fund (MUTF: VUVLX ) 5 (5) Large Value 17.5 (20) Vanguard Energy Fund (MUTF: VGENX ) 2.5 (2.5) Sector 2.5 (5) Notes: ETFs (exchange traded funds) of the same category can be substituted for any of the above Vanguard index funds; e.g. the Vanguard FTSE Europe ETF (NYSEARCA: VGK ) can be substituted for VEURX. Although not included in the Model Portfolio, you may want to consider two other (or additional) international ETFs: the WisdomTree Europe Hedged Equity ETF (NYSEARCA: HEDJ ) and the WisdomTree Japan Hedged Equity ETF (NYSEARCA: DXJ ). These ETFs, unlike the Vanguard Europe and Pacific funds, tend to do better when the US dollar is strong, as it has been since roughly mid-2011. January 2016 Model Bond Fund Portfolio Comments on Our Updated Bond Recommendations Our bond fund recommendations remain highly similar to last quarter’s recommendations. (Note: If you wish to see the Oct. 2015 recommendations, you can go to this link .) We are increasing our allocation to the Vanguard Intermediate-Term Tax-Exempt Fund as muni bonds seem to be one of the best options for both safe and decent after-tax yields. Since gradually rising interest rates could potentially hurt bond fund prices, we are sticking with short and intermediate term maturity funds. (Long-term bond funds have generally done a little worse in 2015 than short and intermediate term funds.) We are dropping Metropolitan West Total Return Bond Fund, included in the last Portfolio, because its performance has not exceeded that of the major bond benchmark, the Barclays US Aggregate Bond Index (AGG). Our Specific Fund and Allocation Recommendations Now (vs Last Qtr.) Fund Category Recommended Category Weighting Now (vs Last Qtr.) PIMCO Total Return Fund (MUTF: PTTRX ) 25% (25%) Harbor Bond Fund (MUTF: HABDX ) 0 (0) (See Note 1.) PIMCO Total Return ETF (NYSEARCA: BOND ) 5 (5) Diversified 30% (35%) DoubleLine Total Return Bond Fund (MUTF: DBLTX ) 7.5 (7.5), or DoubleLine Total Return Bond Fund (MUTF: DLTNX ) (See Note 2.) Interm. Term 7.5 (7.5) Vanguard Intermediate-Term Tax-Exempt Fund (MUTF: VWITX ) 17.5 (15) Interm. Term Muni 17.5 (15) Vanguard Short Term Investment Grade Fund (MUTF: VFSTX ) 10 (7.5) Short-Term Corp. 10 (7.5) Vanguard High Yield Corporate Fund (MUTF: VWEHX ) 10 (10) High Yield 10 (10) PIMCO Foreign Bond Fund (U.S. Dollar-Hedged) (MUTF: PFRAX ) 25 (25) International 25 (25) Notes: When possible, select PTTRX; HABDX is only recommended if you cannot met PTTRX’s minimum. The two funds are the same but have different minimums; select DBLTX if possible because of lower expense ratio.