First off, I'm not fighting the tape. Given the recent run-up, you might not be inclined toward holding large exposure to equities right now, but you've got to be very careful about stepping in front of the stock market train. All politics aside, the fact of the matter is that, generally speaking, equities are currently a strong asset class. Various world markets, such as Israel, Indonesia, India and South Africa, are trading at or near all-time highs. In the U.S., small caps, industrials and basic materials have done extremely well. Led by names like Boeing, 3M, United Technologies and Alcoa, the venerable Dow Jones Industrial Average is poised to kiss its record close.
It's worth noting that many “old soldiers" like Dell, Intel, eBay and Microsoft have been left behind during the recent rally. Certain sectors, such as newspaper publishers, have been hung out to dry even as the major averages have jumped. But, overall, the price action for equities has been higher. To that end, you've simply got to respect the trend.
Want some free advice? Don't pick tops. But while I am not shorting the market, I am mindful of its history and present condition. Dust off your old charts, and you'll recall that the 1987 crash was preceded by a run-up in commodity prices, along with a rise in interest rates and weakness in the U.S. dollar. In today's market, silver is trading like an Internet stock and interest rates are breaking out to multi-year highs. If the U.S. dollar resumes its decline, that "witch's brew" of factors has the potential to dramatically shift the momentum in stocks. This is a potentially worrisome sign that investors should keep on top of in the coming weeks.
One idea you might consider would be to buy volatility. Thanks to a number of new derivatives listed at the Chicago Board Options Exchange, one can now trade volatility as an asset class unto itself. I'm not a value-oriented investor, but from a strategic perspective, it's not hard to make the case that volatility is cheap. For a stock-oriented investor, I think a small position in "fear insurance" makes a brilliant hedge. Sophisticated investors should check out the VIX options page at: www.cboe.com/vix.
The biggest action in the capital markets these days hasn't been the strength in stocks, but the weakness in bonds. From my perspective, this has become the market's most dominant trend. Dig through security after security and you'll find, at least in recent weeks, bonds and bond-related instruments are by far the weakest names on the board.
Along with weakness in bonds has come similar breakdowns in many interest-rate-sensitive sectors, most notably utilities and, to a lesser degree, real estate. The utility sector, which was a major profit center in recent years, no longer shows the persistent leadership or strength it demonstrated during most of 2005. Once-buoyant names like Southern Company or DTE Energy have lost much of their oomph.
Same goes for real estate. While not seemingly as weak as utilities, I'm concerned about the effect higher rates will have on the sector, which is still very much in vogue with yield-hungry retirees. It is no longer a high probability trade in my book.
As always, I encourage you to trade prudently and in accordance with your own tolerance for risk.
Jonathan Hoenig is managing member at Capitalistpig Hedge Fund LLC and is a markets columnist for Smartmoney.com. He appears regularly on FNC's business program Cashin' In.