It never ceases to amaze me how quickly stocks shrug off a potentially disastrous situation and turn it into a positive slingshot of additional strength. The quick spike in tension between Ukraine and Russia has seemingly eased which catapulted stocks to new highs. In fact, high beta equities such as the iShares Russell 2000 ETF (IWM) rocketed nearly 3 percent higher on Tuesday after the perception that calmer heads have prevailed.
This type of momentum and broad-based strength is very telling for a bull market that has overcome many instances of worrisome headlines that seek to derail higher prices. Nearly every major stock index is breaking out to a new all-time high this week, with IWM leading the way. The one exception is mega-cap stocks as measured by the SPDR Dow Jones Industrial Average ETF (DIA), which have lagged since the beginning of the year.
Where the ultimate top will be is anyone’s guess from here, but right now equities are telling us that there is still room for additional upside despite high valuations and global-macro confluences. The market can climb a wall of worry better than any other mechanism for generating wealth because prices are driven by investors whose psychological reactions don’t always coincide with reasonable prudence or doubt. It can also fall out of bed when everything seems rosy.
For most investors, this is probably a point where people are extremely divided between euphoria and cynicism. If you have been long stocks then you are likely continuing to pursue higher prices with the intent of riding the wave for as long as it will last. However, those that have missed the rally are skeptical about further upside and worried about putting money to work at all-time highs. Fear of a quick correction eating into your hard earned nest egg is a powerful motivator to sit on the sidelines.
So how do you find a foothold for stability as the market continues to climb a wall of worry?
The first step is putting aside a bullish or bearish bias and looking at your situation from an objective standpoint. You need to be thinking about putting money to work in areas of the market that offer attractive risk to reward setups with strong fundamental arguments for higher prices. In addition, I always find it helpful to pair equity, fixed-income, and alternative strategies that can help offset volatility in the event that the market turns lower.
In my opinion, we are going to see further bouts of volatility this year which will make for attractive entry points for new money. Investors that are looking for additional equity exposure should be putting together a watch list of positions that they can add to when conditions are favorable.
One actively managed ETF that is on my watch list for inclusion in my portfolio is the Cambria Shareholder Yield ETF (SYLD) which focuses on companies that are buying back shares, paying down debt, or paying cash dividends. This gives you a cross section of 100 companies that are focused on returning value to shareholders by utilizing their cash flow for a multitude of purposes.
Another ETF that I favor is the iShares MSCI USA Quality ETF (QUAL) which is designed to select large and mid-cap stocks that are focused on the following three categories: high return on equity, stable year-over-year earnings growth and low financial leverage. The end result is a portfolio of approximately 124 holdings that have the highest scores in these fundamental categories.
No matter how you structure your portfolio, you should be cognizant of the fact that the trend remains intact and the market can remain imprudently bullish for long periods of time. By taking advantage of modest pull backs and putting money to work with a defined exit point, you can find stability on the wall of worry and enhance your returns this year.