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Dow 12,000…Now What?

With the Dow Jones Industrial Average trading above 12,000 (intraday) the last several trading days, we felt compelled to share some thoughts and opinions on the markets.  For starters, what a wild ride it has been.  It was just under two years ago (in March of ’09 ) that the Dow dipped all the way down to 6,440.08  from a previous all time high of 14,279.96 back in October of ’07.  Simply put, the Dow declined 54.9% and has rallied 86.33% and now remains down 2,279 point or 16.28% off it’s all time highs.

Dow Jones Industrial Average

So what’s an investor to do when “The Market” is up 86.33%, interest rates remain at multi-decade lows and commodities (materials, metals, agricultural, and oil to name a few) are teetering near their all time highs? If you don’t pay taxes, don’t need to spend your money and aren’t worried about inflation, the answer might be nothing.  It is possible you might even “beat the markets” (all of them) by sitting in cash.  The problem is that “relative returns” don’t put food on the table, pay the mortgage or take you on vacation. Furthermore, after taxes and inflation, you really end up going backwards when you go sideways.

If you’re concerned about the markets getting a bit “toppy” and that we are either long in the tooth for a correction of if you are optimistic that  the economy is in a legitimate recovery yet we just need some time to catch up with the strong rebound, click below on “read the rest of this entry”  and see 4 suggestions to help enhance returns and put the risk of your portfolio in check.

Sector Bets- In the beginning of 2009, the Obama administration was moving towards a total health care overhaul that could potentially give tens of thousands of uninsured people access to health care and at the same time the lingering effects of the recession including the “negative wealth effect and record high unemployment would have you think that the American consumer would see his shadow and return underground for the considerable future.  It would not have been an unreasonable bet for an investor to under-weight consumer discretionary stocks and load up on healthcare companies.  As it turns out, in 2010 a year in which the broad markets were up 15.06%, Healthcare was the worst performing sector (up only 3.3%) and Consumer Discretionary was one of the best performing sectors up 27.46%. The morals of the story are multifold with the biggest lessons being that sometimes what seems logical is not and the rewards for being right can be very substantial.  Incidentally sometimes it pays to simply watch for what IS outperforming on a relative-strength basis rather than beating yourself up attempting to figure out what is SUPPOSED to be working.

Tape your balloon with ETF hedging-My preschool age daughters were amazed when I held a balloon in front of them, proceeded to stick a pin in and there was no pop.  The secret was a small piece of scotch tape where I inserted the pin.  If you are worried about your portfolio popping if any or any combination of the equity, bond, or commodity markets turn over, there may be an ETF for you. With the proliferation of available ETF’s over the last few years, there are practically  more choices than there are indices.  Worried about your bonds deflating if interest rates rise?…buy the TBT.  It seeks to track twice (200%) the inverse (opposite) of the daily performance of the Barclays Capital 20+ Year U.S. Treasury Bond Index (that means it goes up when interest rates do). Worried about the overall markets taking a breather but don’t feel like liquidating stocks? …Pick up one of the many ETF’s that either short an equity index or go long on volatility.  Either will do.  Add leverage with a 2 or 3 -1 leveraged fund if you so desire and have the stomach for it. It should go without saying that you need to be careful when implementing these strategies and you don’t want to put yourself in a zero-net-sum situation for an extended period but these methods can help reduce risk and take advantage of volatility in the markets.

Option Selling- Imagine, if you will, a store that sold items that became worthless.  It wouldn’t stay in business very long.  As it turns out, most options expire worthless yet the store never closes (except for NYSE holidays) and you can sell as many as you’d like.  The buyers of options are speculators leveraging their money in hope of big returns but with commensurate risk.  Option sellers are often pragmatic, income oriented investors whose appetite for risk has been shaped by experience and knowledge.   In our previous two blog posts, option series # 1 and # 2, we introduced the strategies of selling calls and puts.   Both can be conservative, income generating strategies that during challenging periods for the overall markets, can offer risk reduction and enhanced returns as compared to simply holding a diversified portfolio of common stocks.

High Yield Bonds- Ok, Ok you Baby Boomers…Yes, we know that you remember before the days of Ivan Boesky and Michael Miken, when these were called junk bonds.  Well, we are here to tell you that their birth-name may be a real misnomer and if you are holding on to a portfolio of treasury, municipal, investment grade or corporate bonds, you may be feeling like a junk yard dog if interest rates rise quickly and the value of your bonds plummet. Many bond mutual funds will fall further and more swiftly.

The truth of the matter is that there are many, many companies with solid revenues and quality management but their balance sheets or leveraged nature of their business simply can’t earn them an “investment grade” rating and so they are forced to borrow from the bond buying public at a premium.  A  high yield bond investor not only benefits from owning higher yielding bonds but they also have a far less interest rate sensitive portfolio. If you do your homework about what to look for and avoid in this arena (or have it done for you) and spread the risk around by buying smaller positions from multiple issuers, you may find yourself earning double to triple what you might earn in a treasury or investment grade bond and your heart won’t skip a beat when interest rates spike.  Best advice on choosing the right bonds for your portfolio is don’t be greedy.  The bond market is arguably “smarter” than the stock market so if you see an issue with a coupon rate that is very, very high (well north of 7%) stay away and if you see an issue trading at a deep discount to par ($1,000 per bond) you may want to stay even further.  In today’s interest rate environment, earning in the 5-6% range for a portion of your portfolio without exposing you to unnecessary interest rate risk may prove prudent.

We hope that you appreciate these tips for helping enhance the returns of your portfolio while ratcheting down the risk. If you appreciate any of these points or would like to add any of your own, please share your thoughts in the comments section.

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