Sunday, March 16, 2014

The Week Ahead: Stocks or Bonds?

With the outcome of the Sunday's secession referendum in Crimea along with the slowdown in China weighing on investors' minds, risk sentiment is starting to sour again, so MoneyShow's Tom Aspray tries to answer the question of where to stash your cash during these uncertain times.

The global stock markets had a rough week with the Asian markets hit the hardest but the Eurozone and US were also under pressure. Still, the US averages are holding well above the prior swing lows. The Russian market has been one of the worst, down over 27%, so far this year, and if they are hit with sanctions it will get worse.

The combination of the continuing crisis in the Ukraine and more weak data out of China has increased the fear amongst investors. It is hard to tell how far Putin will push the West as his behavior over the past few years seems to be steroid induced.

The ups and downs of investor sentiment have been quite typical since the end of 2013 when the bulls dominated, but in just over two months they have become more nervous. Those who decided to buy if the market declined seem to be having second thoughts.

There has been some new buying in the bond market as their safety has become more attractive. As I discuss in more detail in the technical section, given the current stock market outlook, I am not expecting any more than a 5-7% correction, and it could be less. Therefore, I still think it will provide a good buying opportunity in select stocks and last week's recommendations in Is Your Portfolio Well-Positioned? are generally acting well.


This comparative chart of the German Dax and the S&P 500 Index shows that the recent decline has been much worse in the German market. Since the June 2012 low, it is sill up over 51% vs. 43.5% for the S&P 500. However, the Dax is down 11% since the late-February high while the S&P 500 is down just a bit over 2.5%.

The fact that the Dax has dropped below both the December 2013 and February 2014 lows has weakened its chart. The concern over the euro's strength has jumped in the past week as the ECB already seems to be questioning its recent decision on rates.

So what are the prospects for buying bonds now? The yield of the 10-year T-note shows the spike in yields two weeks ago to 2.82% but they have since dropped down to 2.63%. The broad trading range (lines a and b) that we have been watching for the past two months is still intact.


The key support in terms of yields is in the 2.47% to 2.50% area with the October 2013 low at 2.47%. The completion of the major bottom formation in May of 2013 does still suggest that this range is a pause in the trend towards higher rates.

A strong weekly close in yields above 3.02% would be an upside breakout and signal a move to the 3.4-3.5% area. For those in the short-duration bonds (5.6 years), as represented by the Barclays US Aggregate Bond Index, this would mean about a 5.4% drop in the value of their bonds. Since old bonds would be replaced by newer ones at higher yields, the damage would likely be less.

If the average maturity of your bond holdings is 13.4 years, such an increase in yields could mean over a 13% loss. Of course, the long-term bonds will do even worse as they were down 12.7% last year. Since the start of last summer, I have been recommending that bond holders shorten the maturity of their bond portfolio. On the technical side, the downtrend in the weekly MACD (line c) continues to favor lower yields for now.

Therefore, the investor has to decide between the current 2.3% yield of short-duration bonds that have a potential downside of 5% if rates spike and the stock market rallies. I continue to think the S&P 500 will show double-digits gains some time in 2014. Of course, if you are buying below the 2013 S&P 500 close of 1848, it could be even greater. The risk is that you will bail out if the selling gets too ugly and not be on board for the inevitable rebound.

NEXT PAGE: What to Watch

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