We're Approaching a Stalemate

The markets are on their way to post their best performance for a month of August in 14 years, mostly as the result of a better-than-expected quarterly earnings season. The S&P 500 crossed over the magical 2,000 level this week for the first time in the index's illustrious history. This has occurred despite escalating tensions in Ukraine, an economy in Europe that feels like it could turn over and ISIS on the march in Iraq. It was quite a remarkable month for equities, given the circumstances. However, with earnings season pretty much over and with the Federal Reserve finally on the brink of ending the last of its major quantitative easing programs in October, I believe investors should be cautious here. S&P 2000 could turn out to prove a major resistance point. It feels like a stalemate between the bulls and the bears could be in the making over the next few weeks. One could feel these cross currents in yesterday's market. Equities initially declined on the deteriorating situation in Ukraine as the Russians increased their incursions into the country. But stocks improved after the European bourses closed and on the back of an upwardly revised Q2 GDP report. Indices ended modestly down for Thursday on anemic trading volume and the 10-year Treasury yield continued its year-long decline, moving closer to 2.3%. I don't believe the direction of the market is clear right now, and I am more concerned about the ending of the latest quantitative easing program than most pundits. Equities declined sharply after the completion of QE1 and QE2. Will the outcome be different at the end of QE3, with the markets selling at higher earnings multiples? Given this uncertainty, I am keeping a higher than usual allocation to cash in my portfolio. I am increasing my exposure to Europe slightly, as I believe the European Central Bank will eventually have no choice but to engage in its own quantitative easing initiative to keep the continent from slipping back into recession. This easing should boost European equity values as well as put pressure on the euro. I would avoid adding any new funds to companies that get a significant portion of their sales from the eurozone, as they are likely to suffer currency hits to their earnings. I have also added some shares in Netherlands-based insurer AEGON (AEG) recently. QE in Europe should bolster financial shares and the decline in the euro will help earnings as the insurer gets roughly two thirds of its revenues from North America. Shares are priced at more than a 40% discount to book value and yield over 3% dividend to boot. Most new positions domestically I have initiated via just out-of-the-money bull put spreads. This provides a nice premium income pick-up if my targeted stock stays where it is or moves up. If it moves down, I pick up attractive shares at a discount. I recently did this with the April 2015 $26/$16 bull put spreads on Chesapeake Energy (CHK), which I managed to get $2 a spread on, with the stock selling just above $26 a share. I like Chesapeake longer term, and already own some of the equity outright, as the company seems to be initiating the same game plan that Devon Energy (DVN) and Hess Corporation (HES) have used so well to create substantial shareholder value. Chesapeake is selling or spinning off non-core assets and operations, reducing debt, consolidating operating areas and reorienting its capital budget to become more oily in its overall production. Chesapeake is still early in its transformation, but it is a story worth watching. I think investors need to be prudent here, with the market at or near record levels, and the direction for equities a bit opaque at the moment.

We're Approaching a Stalemate

The fight between the bulls and the bears is intensifying.

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