The correction I've been warning about entered a new, more dangerous phase Monday as reality began to set in among even the most ardent bulls. With just five weeks left in the Fed's $600 billion QE2 initiative, seen by many as a panacea for all the world's ailments, investors are beginning to worry. And they're beginning to sell.
As a result, the sell-off that was relegated to commodities, energy stocks and foreign shares has started to pull the major U.S. averages through major technical support levels and down out of multi-month trading ranges. Even defensive stocks in areas like health care and consumer staples, which have been market leaders recently as savvy traders looked for protection, are plunging along with the overall market.
There are many catalysts. For one, there is no doubt that the eurozone debt contagion is mutating into something so virulent that it now threatens not only Greece and Ireland but also Spain, Italy and Belgium. Japan, the world's third-largest economy, has plunged back into recession. And here at home, the economy is stalling badly just as rising inflation and unsustainable debt levels force the Federal Reserve and Washington to back off on stimulus measures.
Here's a look at the situation, along with two new trade recommendations discovered with the help of Fidelity's ETF screener.
The fact that defensive, non-cyclical stocks like Kraft (KFT) and Johnson & Johnson (JNJ) are now participating in the decline has pushed the major stock market averages below important technical levels. That's the trouble will getting bullish about these types of stocks, which have been on a tear over the last two months.
Defensive tend to outperform cyclical stocks like materials and energy for a short while on the upside before the overall market tips lower. The bulk of the time defensives enjoy relative outperformance is on the downside. In other words: The big advantage to non-cyclical stocks is that they don't drop as much as the rest of the market during prolonged selloffs.
I said as much way back in February when I first warned of trouble for stocks and again in late April.
Now, things have changed. And for most investors, we've entered a period where a large cash position is probably the best bet. The traditional safe haven, Treasury bonds, look vulnerable to a pullback as the United States moves closer to a possible technical default in August if Republicans and Democrats can't agree on a way to get the country back on a sustainable fiscal footing.
For the risk takers out there, here are two new trades that I've recommended to my newsletter subscribers to help profit from the broad market weakness.
ProShares UltraGold (UGL)
Despite the dollar's recent gains, gold has been stabilizing and moving higher over the last two days. This suggests that the tight correlation between gold and the dollar is breaking down -- freeing the yellow metal to trade based on its own supply-demand fundamentals. It's worth remembering that the long-term fundamentals for precious metals were quite positive -- as I outlined in my Apr. 21 column "Why gold could hit $5,000."
Gold in particular looks very strong as global risks ratchet higher. And most of the speculative hot air in the precious metals was relieved by silver's dramatic plunge this month. With sentiment low, I'm looking for gold to push higher as investors look for safety. The ProShares UltraGold should be a big beneficiary of this.
ProShares UltraShort Semiconductors (SSG)
Chip stocks resisted the selling pressure that plagued energy and materials stocks earlier this month. They can resist no more as broad selling takes down the entire market. The sector, as illustrated by the Semiconductor Holders (SMH) in the chart above, is falling out of a four-month topping pattern and should be good for a retest of its March lows.
Semiconductor stocks are among the most sensitive to fluctuations in the economy cycle. If growth is indeed stalling, chip stocks will be among the hardest hit. The UltraShort Semiconductors ETF, which returns twice the inverse daily return of Dow Jones U.S. Semiconductors Index, will move higher as chip stocks move lower.
Disclosure: Anthony has recommended SSG and UGL to his newsletter subscribers.
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The author can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. Feel free to comment below.
Brian:
Spot on! Sadly these talking heads are not held accountable for what they say. They just talk in the moment. It would be nice to see higher unemployment in talking head land; everyone would be better off to just ignore them.
Time to stop re-hashing old news. Companies are not going bankrupt, their earnings are solid. Unemployment is going to remain an issue primarily because we have reached market saturation in housing and so many jobs are dependent upon construction. Once we move into another growth area (like we did when the steel industry died in the 1970's) the US economy will stabilize. Until then, it is going to be a rocky ride.
Bill in Omaha: Word will syntax check, but only if you turn on the option.
Anthony,
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