Though the Fed has been buying Treasuries, not supporting the stock market directly, the effect is the same. As bond yields have been driven lower, money chasing a return has been forced into the stock market. There is plenty of money chasing a return too, with the Fed adding $85 billion dollars per month of liquidity. Any hint that this could come to an end is likely to cause sustained selling in both bonds and stocks.
Friday was ugly, so a bounce back early this week was to be expected. Long-term, I believe the recovery will continue, and the market will reflect that. My concern is that before long, we could see a sustained move down, a mini-crash even. I am not a doom merchant; I just believe it is now possible over the coming weeks.
So, what should you do? The short answer is "something". From my own experience, and especially my time as an advisor--stopping yourself from making mistakes is one of the most important things you can do. Many advisors will tell you to do nothing, ride out any storm. The issue for most is that they do this for a while, and then start dumping stock when the pain gets too great. Taking a small position now in something that will benefit from a lower market is a smart move. If a drastic move down comes, you will feel that you have done something and be less inclined to sell out near the bottom.
Generally I am not a fan of leveraged bear ETFs. They are traders’ instruments best used for intraday hedging. Daily re-sets and a high fee structure make them completely unsuitable for long-term holding. In this situation, however, where you have concerns over the next few weeks, a small position in something like the Direxion Small Cap 3X Bear ETF (TZA) would be a good idea.
If the sequestration issue is sorted, the Fed stands firm and the recovery picks up pace, you won’t do too much damage in a couple of weeks. If my fears are confirmed, however, having something in your portfolio that is making money can stop you from making rash decisions. As always, hope for the best, but prepare for the worst.
Martin Tillier brings a unique perspective to writing about financial markets. He spent 18 years working in the Foreign Exchange market, initially in his home town of London, then in the Tokyo, Moscow and Warsaw. His job as a broker required an in-depth knowledge of the workings and interconnectedness of various markets and, perhaps more importantly, an understanding of the psychology and techniques of traders.