The tragic earthquake that devastated northeast Japan also has struck the global economy. And the natural disaster comes after several other blows that have hit the economy lately. Rising prices for food and oil, turmoil in the Middle East and belt-tightening by deficit-hampered governments all have weakened the prospects for strong growth.
Amid all the unsteadiness, investors are looking for ways to protect their portfolios against rising risks and potential losses. Some sectors and investments might be well placed to hold their own — or even gain — in the current atmosphere of uncertainty and heightened risk.
And as the global economy has grown, investment opportunities have expanded. New exchange-traded funds (ETFs) have popped up for popular investment categories, such as precious metals and emerging markets.
It’s impossible to review all of the hundreds of investing options in the global marketplace, so I’m aiming to get a snapshot of the market by reviewing six charts that cover a spectrum of options: the tech-dominated NASDAQ; emerging markets, as covered by the EEM ETF; gold, via the GLD ETF; the energy sector, through the XLE ETF; bonds, via the TLT Treasury bond fund; and currency, with the U.S. dollar index (DXY).
Diversity Reduces Risk
My reasoning for this selection is based on a simple investing principle for lowering risk: choosing a variety of investments that are inversely correlated — meaning they act as a seesaw: when one is up, the other is down, and vice versa — or weakly correlated, meaning they move up and down independently of each other.
Markets that move in lockstep don’t really offer any meaningful diversity or hedging. Owning a portfolio of sectors and markets that move together is equivalent to putting all your eggs in one basket. So the key to hedging your bets is picking investments that behave differently in different scenarios.
For example, the dollar and U.S. bonds have a strong inverse correlation with equities — meaning that when stocks decline, bonds and the dollar tend to strengthen — so I’ve included them as potential hedges against stock-market weakness. Oil prices have risen sharply, so I’ve included an ETF for the energy sector.
And as the U.S. economy has worked its way through the recession, many investors also have turned to emerging markets and precious metals in the hope of higher returns, which is why I’ve also included exchange-traded funds for those sectors.
To screen out the noise of daily trading, I’ve selected long-term weekly charts.
The tech-heavy NASDAQ has been on a tear, along with the SP 500 and the Dow Jones Industrial Average, but there are signs that the uptrend is running out of steam: indicators have rolled over and the price is testing the 20-week moving average. A decisive break below this line could lead to a test of the 50-week moving average around 2,450. Broadly speaking, this area offers resistance and support going back to pre-recession 2008, and should be watched carefully.
Emerging markets have remained flat since the middle of January, trading in a narrowing band which has traced out a pennant or wedge, a pattern which technicians view as evidence of indecision. This lack of direction is also visible in the tightening Bollinger bands, a move that reflects decreasing volatility.
Wedges and narrowing Bollinger bands typically lead to major moves either up or down, and an accompanying increase in volatility.
There are troubling signs of weakness here: The price has fallen below the 20-week moving average, which now acts as resistance, and the trend indicators have turned down. An open gap at 42 beckons, signaling that the price could dip down to fill that gap.
There’s not much bullish evidence here, and plenty to signal caution.
Precious metals — including gold, silver and platinum — have all registered strong gains. This run had led some observers to discern a speculative bubble in gold and silver. A glance at this chart finds little evidence for speculative extremes. Instead, it shows firm and steady growth, even though the price dips down to test the trendline from time to time.
The moving average convergence divergence (MACD), an indicator used to calculate buy and sell signals, remains bullish as well. Gold could suddenly reverse and crash — that’s always a risk in any open market — but there is precious little technical evidence that such a crash is imminent.
As might be expected when stocks swoon, Treasury bonds — here represented by the TLT bond fund — have gained. Both the MACD and the lower Bollinger band in this chart have turned up, signaling a trend reversal from a previous decline. Prices have reached the 20-week moving average, and a breach above this line would help confirm that an uptrend is taking hold.
In the past few years, when equities slide, bonds have outperformed. Conversely, when stock have roared ahead, bonds have slipped. Is that historical correlation holds true, bonds may be expected to strengthen if stocks fall into a pronounced downtrend.
The U.S. Dollar
Like bonds, the dollar acts as a so-called “flight to safety” or “safe haven” when stocks swoon. The dollar has risen sharply in stock downturns, topping out when the stock market bottoms. Prices have fallen to support — meaning they seem to have bottomed out — around 76, potentially tracing out a bullish double-bottom pattern.
The psychology of a double bottom is common sense: If the price holds at previous lows, investors believe that “the bottom is in” and the coast for gains is now clear.
A Stochastics reading, which compares the current price to historical prices, indicates that the dollar has been deeply oversold and suggests that investor sentiment has reached its lowest point. That bearish climax means that a reversal is likely, as the market rarely rewards the majority for holding the same position as everyone else.
Once again, stocks and the dollar are on a seesaw: If stocks slip, the dollar tends to rise in value.
Oil and Other Energy
The XLE energy ETF’s chart clearly displays the extraordinary run that oil has experienced in the past seven months. The indicators have turned down, mirroring the recent weakness in price, which is testing the trendline. Despite this recent decline, prices remain well above the moving averages, which means that energy is still in an uptrend.
No market advances in a straight line forever, so some pullback would be natural. Is this the first step in a major trend reversal, or merely a pause that refreshes the oil bulls? That is impossible to say just yet. Some significant level of support, such as the 20-week moving average, would have to be broken to truly call the uptrend into question. It would not be surprising for price to dip down and test this support, as those who have profited handsomely from this bull run pocket some gains.
But any market that has climbed this far this fast bears close monitoring.
No market is immune to risk and uncertainty, of course. Markets that look strong can suddenly reverse, while those that look sickly can suddenly rebound. Still, a watchful analysis of trends and market correlations can offer investors some clues about risk and potential returns in these uncertain times.
Tagged: bollinger bands, DXY, EEM, emerging markets, Energy, energy stocks, ETF, etf investing, ETFs, GLD, gold