As we near the mid-point of the year, just over a month away, my stock market advice is to adopt a cautious approach; especially on the buy side. If you are looking to add to a long-term portfolio, it’s likely fine to buy on stock market weakness. But for those with a shorter time horizon, you need to be careful, because the vulnerability of the downside is above average.
Stock Market Rife with Uncertainty
On the charts, we are seeing stalling driven by the upside resistance. The S&P 500 has repeatedly failed to break higher from its current sideways channel at around 2,125. The broad market index is only slightly above breakeven in 2015.
On the technology and growth ends, we are seeing some hesitancy in buying higher beta stocks. The lack of stock market leadership from the technology sector is capping gains. The failure of the NASDAQ to hold after numerous moves above 5,000, including a record move, is a red flag. There may be some concerns on the part of investors thinking back to the technology implosion in 2000, but the moves this time around have generally been steadier.
At issue now is not only the fear of higher interests rates on the horizon, but also the recent surge in bond yields in Europe and domestically as investors sold off bonds. The advance in higher yields has taken a break; and there continue to be stock market uncertainties.
The eurozone is continuing to show positive gross domestic product (GDP) growth with improving business conditions in Spain and Italy—two of the region’s laggards. Of course, Greece continues to be a drag as it negotiates a revised austerity and debt program with its lenders. Greece even had to take 750 million euros from its IMF emergency funds in order to make a recent bond payment. The country is flat out broke and will need even more concessions.
In China, the People’s Bank of China cut its key lending rate by another 25 basis points, representing the third cut since November. The country is trying to avert a hard landing. Exports in April fell about six percent, which is helping to slow manufacturing in China at a time when the country is trying to shift to a consumer-driven GDP model and rely less on exports. Long-term, I remain positive on the growth potential in the country, but would be cautious for the time being.
My Stock Market Advice in This Market
Recently I talked about using put options as a defensive hedge against potential stock market weakness.
Given that the upside looks somewhat guarded for the next few months as the stock market tries to find its bearings, I suggest looking at generating some premium income through the selling of covered call options on your underlying positions. This trading strategy implies the stock market will not likely surge higher over the time of your options. And if the play is wrong, all it means is that you would be required to sell some of your holdings at the higher strike price you selected.
In my view, it’s a win-win situation. In addition, you can use the premium income from writing the call options to help pay for the cost of buying put hedges.
As long as the stock market doesn’t surge higher prior to the expiry of the call option, you should be fine, creating a low-cost strategy to protect the downside.