May 5 2014, 11:42am CDT | by Forbes
In the second year of a four year Presidential term (as is the case in 2014), the stock market has historically been weak, usually forming a bottom in the second or third quarter. This Presidential term behavior for the markets has been very consistent, dating back to World War II. No better year to follow the old adage of “sell in May, and go away”, right?
Not so fast. We also know that in the 60 years since 1954, there were 14 times when the stock market rose at least 20% in a calendar year. And, in the year following these 20%-plus yearly gains, the market rose, on average, more than 10%. If stocks achieve even the average return that this historical precedent would suggest for 2014, the stock market should achieve a significant gain sometime before the end of the year.
So, the question becomes, how do investors play it right now?
With the seasonally weak period for stocks ahead of us, investors might be wise to heed the old adage of selling in May, but with a twist, given that stocks could achieve a decent return by the end of 2014.
Rather than simply selling and sitting on the sidelines, we recommend diversifying growth portfolios into some other areas. It’s worth considering investment ideas that offer solid potential return, plus a reduction in total portfolio risk compared to a portfolio dominated by U.S. growth stocks. Concentrating in a few hot sectors worked well in 2013, but this year broader diversification and risk reduction are in order.
So where to diversify? Increasing exposure to large-cap value stocks makes a lot of sense in this environment. This area also offers lower volatility and low correlation relative to the high beta stock sectors.
The Guggenheim S&P 500 Pure Value ETF (ticker symbol: RPV) is a particularly interesting way to play this trend, as the past performance of this ETF stands out compared to other large value offerings. By adopting a “pure” value play, this fund emphasizes areas such as energy, financials, and utilities.
Investors should also look overseas to a newer subcategory of emerging markets, termed “frontier markets”. This sector is made up of countries that are smaller and less economically developed than the BRIC countries (Brazil, Russia, India, China) that have become synonymous with emerging markets.
Many of the frontier markets are found in the oil producing Middle East, or in former Eastern Bloc countries that are resource rich. There’s plenty of long range growth potential, but at this point in their development, with volatile swings and less transparency, an investment in the frontier markets likely deserves no more than a satellite position in a portfolio.
Forward Frontier Strategy Investor (ticker symbol: FRONX) seeks to replicate the MSCI Frontier Markets Index and is an attractive vehicle for this category. ETF investors, willing to take on considerably more risk, can also consider iShares MSCI Frontier 100 ETF (ticker symbol: FM).
To achieve even more diversification, investors should consider other areas, beyond common stocks. With the yields on U.S. Treasuries and other bond investments quite low, high yielding preferred securities are favorable in the current environment.
The Market Vectors Preferred Securities ex Financials ETF (ticker symbol: PFXF) offers a high dividend yield (more than 6%) and stability to offset more volatile stock positions in a portfolio. In addition, since this ETF does not invest in preferred securities issued by financial companies, the resulting industry mix (mostly utilities) results in a reduction in risk compared to many of its peers. Preferreds should remain attractive until we get a sustained rise in interest rates.
This year has certainly brought a much different market environment compared to last year, and as a result, investors need a shift in strategy. If the past is prologue, the question remains, which past will play out this year? We believe it’s best to hedge your bets with broader diversification right now.
David Kudla is CEO and Chief Investment Strategist of Mainstay Capital Management, a fee-only, independent, Registered Investment Advisor. More information about his firm can be found at www.mainstaycapital.com. Follow him on twitter at David_Kudla.
Disclosure: Clients and employees of Mainstay Capital Management may hold the securities mentioned in this article in their investment portfolios. The securities mentioned may not be suitable for some investors, based on their tolerance for risk or their investment time horizon.
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