There were some decent performance metrics through January, but whether we are witnessing a revival in economic growth or a market head fake remains to be seen.
Nevertheless, the numbers were good in the interim: the S&P/TSX 60 index was ahead by 5.5% in January 2012; the S&P 500 composite index was up by 7.2%; and the Nasdaq 100 topped all the indices with its 11.1% return.
Some believe January sets the stage for the coming year; but for many, the performance seems illusionary, considering the tepid outlook for economic growth in Canada and the rest of the world. There is, to say the least, lots of bad news on which to make a case for a bear market.
Case in point: Europe, which apparently is slipping into a recession. And other markets in which we traditionally have seen growth have their own problems. China is wrestling with a soft landing, something that few central banks have been able to orchestrate successfully.
India, according to research from Morgan Stanley Smith Barney, is suffering from a slowdown in domestic demand and persistently high inflation.
And although Brazil looks healthy, we have a dangerous cocktail brewing — in which above-average, private-sector expansion is being met with well-intentioned but often futile socialist policies.
The elephant in the room, of course, is the U.S., the economy of which everyone, except those who speculate in the stock market, believes is fragile. Retail spending is anemic, as consumers continue deleveraging while awaiting a bottom in the real estate market. Then, there is the political logjam in Washington, D.C., that shows no sign of abating until we get through the 2012 election year. It is difficult to see how the U.S. will generate above-average growth from the private sector.
Still, the markets seem intent on climbing this wall of worry. And now, with the banking sector looking as though it may have bottomed, we may start to see some leadership from that sector.
Better than expected numbers from the Goldman Sachs Group Inc., Bank of America Corp. and Morgan Stanley in January have added fuel to that belief. And that’s not even mentioning the enthusiasm surrounding the initial public offering for Facebook Inc., led by Morgan Stanley, which is even more good news for this sector.
With bank fundamentals improving, there is opportunity to provide more credit to the private sector. Credit expansion leads to economic growth and, in short order, higher stock prices — at least, that’s the theory.
Market sentiment also is positive, as is indicated by inexpensive options premiums. At the end of January, the Chicago Board Options Exchange’s volatility index closed at 19.44 and continues to decline. These numbers are well below the 200-day moving average, which is a quick and dirty indicator of fair value.
The bottom line: your clients can hedge their bets through the purchase of inexpensive put options on the major market indices. Effectively, investors can remain in the game should the bullish argument prove correct, while limiting exposure to the downside should sentiment shift toward the illusionary aspect of current performance numbers.
You also might consider defensive positions on index funds, such as iShares S&P/TSX 60 Index Fund (symbol: XIU; recently priced at $18 a share), the S&P 500 despositary receipts (SPY; US$134.35) or PowerShares QQQ (QQQ; US$62).
Trades to consider include buying XIU June 18 puts, SPY June 134 puts at US$6.10 or the QQQ June 61 puts at US$2.55.
Another way to play this market is to buy calls on the Big Six Canadian banks. These are more aggressive trades because you must believe that the Canadian banks will follow in the rising footsteps of their U.S. counterparts.
If you think they will, you should look at buying short- to medium-term (i.e., nothing longer than June expiration), at-the-money calls on any one of the six major Canadian banks. IE