What Does This Market Remind Me Of? You May Not Want to Remember

 | Mar 07, 2018 | 9:00 AM EST
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There have only been a few periods in my life I can recall during which markets rocked back and forth on virtually any headline, when the fear and greed were palpable.

The first time was around the time of the Lehman Bros. collapse in September 2008. Would they let Lehman go? What would happen to Merrill Lynch? What about Morgan Stanley (MS) and Goldman (GS) ? Would AIG (AIG) get bailed out? Investors were waiting for the next headline from Moody's or S&P to roil the markets. We were fixated on the TARP vote. Would politicians do the right thing?

The other time that trading felt manic and headline-driven was late fall of 2011 at the heart of the European debt crisis. Was Spain next to go? Italy? Which large European bank was at risk? Did Merkel and Sarkozy come out of the meeting holdings hands or were they avoiding making eye contact? Politicians we had never heard of could move the S&P at whim. Rating agencies ruled the day.

During both periods, we had wild swings nearly every day and sometimes even during the same day. There were multiple times to feel really smart and to feel really stupid.

Basically, confusion was a common emotion felt by traders and strategists. I think confusion reigns again here. I, for one am, willing to admit that this market has been the most confusing I've seen in some time. The best laid plans could be disrupted by a single news conference.

It is extremely difficult to take a step back, take a deep breath, and prudently manage your money and positions in times like these, even though that is when it is most important.

Will there be a trade war? That is the latest question to rock markets. It is a good question and one where the answer seems to be yes, if President Trump has his way -- but no, because Congress won't let Trump have his way.

That battle, being fought out with whispered phone calls, big news conferences, leaked news reports and on Twitter, has caused the market to careen around for the past few days.

But it was gyrating wildly before this. We went from VIX and risk parity, to stock buybacks, to growth, to trade wars, all in a matter of weeks. I don't know what is lurking around the corner. I suspect the trade saga isn't done, but I'm confident that something else will also become the topic of the day.

Volatility Has Increased

Whether we like it or not, realized volatility has increased. If you are uncomfortable with this volatility, reduce your risk. Cash barely moves. I don't want to sound obnoxious, but if you are uncomfortable with the current level of volatility in your portfolio, reduce your risk now while stocks and most bonds are doing OK.

I want to be positioned to embrace the volatility. These periods of volatility are exactly what I look for to enhance returns in an income portfolio. We had been cautious coming into this and are able to trade a bit and manage risk to create not only higher returns, but ideally higher returns for any given level of risk taken.

But if you are nervous, reduce risk now, because if I am right, this volatility will continue and the nervousness and losses will force you to sell something just as I am jumping up and down and pounding on the table and saying to buy it.

Credit Risk Is Materially Weaker

Stocks rose Monday and it's worth noting that credit isn't rebounding. CDX indices are only a smidge better and that is after taking a beating last week. High-yield ETFs were barely up Monday. Investment-grade bonds that were issued in the middle of last week are almost universally quoted wider and barely trading (not a good sign).

I cannot remember the last time I wanted to highlight relative underperformance in the credit market, so this is a material change.

Treasury Yields Grind Lower and Gap Higher

I have seen the Treasury market trade poorly of late. The moves to lower yields seem difficult to achieve but the moves to higher yields seem ferocious.

I sent a chart a couple of weeks ago pointing out that Treasury yields tended to bounce off of resistance at least twice. Well, we have bounced off of 2.95% now a couple of times, so I would not own longer-dated bonds here. I think there is a risk of gapping through 3% and hitting 3.25% before we know what happened.

I like three- to five-year Treasuries, or an ETF like iShares 3-7 Year Treasury Bond ETF (IEI) , although that goes out to seven years.

China Is a Dangerous Enemy to Have

I will not inundate you with more trade war information, I just want to say two things. China could look to advance telecom equipment maker Huawei Technologies Co. Ltd.'s interests at the expense of companies like Apple (AAPL) . Also, China owns over $1 trillion of U.S. Treasuries, which it could choose to dump into this already weak market for bonds of all types.

On the Edge of Risk

I edged up toward maximum max risk and I would edge back toward less risk. I don't like owning a lot of interest rate risk; long-dated Treasuries and long-dated IG bonds and munis should be reduced.

I like the belly of the curve, around five years.

I'd rather own high-yield bonds 2% and sell some every time they rally 3% -- net, increasing our position, but cautiously. Do not be afraid of booking some profits on rebalancing and trading.

If you are nervous about your positions here, then I think the prudent thing is to take some risk off, otherwise you risk being your own worst enemy if the volatility continues, which I expect it to.

This article was originally sent to subscribers of TheStreet's Income Seeker, a product presenting the world of opportunities in fixed income and dividend stocks. Click here to learn more about Income Seeker and to receive articles like this from Robert Powell, Peter Tchir and others.

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