The main market story of the last few years has been the meteoric rise in equity markets valuations since the global financial crisis came to a close. The recovery in the SPDR S&P 500 (ARCA:SPY) has been nothing short of impressive but it must be remembered that the central driver of this market activity has been the willingness of policymakers at the US Federal Reserve to inject monetary stimulus and provide additional support for the US economy. Since so many other countries (for example, China and other emerging markets) rely on the United States to buy its export products, this activity helped support the prospects for stocks in many other areas of the world as well, so to discount any of these developments as central in terms of importance would be a huge mistake.
Federal Reserve and the Stock Benchmarks
But if you have been reading the financial headlines in the last few weeks, you now know that many of these factors are coming to an end. “Specifically, comments from Fed Chairman janet Yellen and several other voting members of the US central bank have now made it clear that QE stimulus programs will be over by the fall,” said Jonathan Millet, market analyst at ForexMinute, “and this sets the stage for the Fed to begin raising interest rates as long as the US and global economy continue to progress in an orderly fashion.” This is a negative not only for stock markets but for precious metals ETFs like the the SPDR Gold Trust (ARCA:GLD) and theiShares Silver Trust (ARCA:SLV). This is largely because gold and silver are priced in Dollars and when one asset class goes up the other asset class tends to post declines.
If the Fed is reducing monetary stimulus, it literally means that there will be fewer Dollars available in the US and world economies. The basic laws of supply and demand indicate that this is a bullish scenario for those that are holding onto Dollars and avoiding excessive exposure to other asset classes (such as stocks and commodities). For these reasons, those that are long on the United States Oil Fund (USO) should consider trimming exposure in favor of dollar ETFs like the PowerShares Dollar Bullish USD Index (UUP).
Downside Risk
In summary, those that are still dealing with significant exposure in equity markets it makes sense to start trimming back on positions with prices trading at their elevated (and in some cases all-time record) levels. This is because downside risk far outweighs upside potential and from a fundamental perspective there are several reasons to believe that corporate earnings projections are going to be reduced as stimulus programs are phased out. The financial markets are in for some interesting changes in the coming months and it is not entirely clear that most investors are positioned appropriately or well prepared for what is coming next.