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Strategies for a sideways market

The market may look sideways, but beneath the surface there may be trading opportunities.

After posting tremendous gains over the past five years, stocks seem to be taking a breather. The broad market has gone virtually nowhere this year. But that doesn't mean things haven’t changed under the surface. Top-performing sectors and industries, monetary policy, and the drivers of growth and risk around the world have been in flux—creating uncertainty and opportunity.

At the May 2 Traders' Summit in Chicago, Fidelity brought together hundreds of traders and some of the industry’s best minds to discuss the state of the economy and markets, and strategies and tools to use while the markets go sideways.

The markets may be going sideways for now, but Steve Forbes sees reasons for optimism—and numerous opportunities for investors willing to break from the crowd. Here are the highlights from his far-ranging speech on the economy and the markets.

A long way from euphoria

Sir John Templeton famously said, “Bull markets are born on pessimism, grow on skepticism, mature on optimism, and die on euphoria.” We’re a long way from euphoria, and even optimism. Barring a major foreign crisis, the market still has plenty of upside left in it.

The economic outlook

Barring a major foreign crisis, the U.S. economy, despite a lousy first quarter, is going to do better the rest of the year. We’re sort of like a baseball player who bats .150 and this year may get it up to .250, when he should be batting .350. Better, but not what it should be. One reason for the improvement is that bank lending is starting to go up again. Commercial/industrial loans have been growing at a double-digit pace for the first time in a long time.

While it may sound counterintuitive, one reason we have had such subpar economic growth is that quantitative easing held back the economy, in my view. The Federal Reserve tried to suppress not just short-term interest rates but also long-term rates. In essence, the Fed went in the game of credit allocation and made it very easy for the government to borrow, very easy to buy mortgage-backed securities, and very easy for large companies to borrow. But small and new businesses have had a more difficult time getting access to credit. So, I think the taper actually means the Fed is making credit less restrictive for small and medium-sized businesses—the more the Fed tapers, the more money is going to be available for the rest of the economy.

The outlook abroad

Overseas, it’s very, very mixed. The U.S. is the global engine right now. In Europe, the United Kingdom is doing better—lot of investment opportunities there. Germany looks OK but seems to be going backwards on some of the economic reforms that it made a decade ago. The rest of Europe has been showing more signs of life. But the fact of the matter is Europe is still in terrible condition, better than it was a year ago, but not anything that’s going to bring the world along.

Japan, even though they have a prime minister who wants to get that economy moving again, just raised their national sales tax from 5% to 8% and they’re raising capital gains taxes and payroll taxes. Not much good economic news there.

In China, the economy may be slowing, but its leadership wants to make serious reforms to create real financial markets in that country. So China may be troubled now, but if the reforms start to really kick in, watch out. China’s growth is going to resume.

Emerging markets have struggled in the last year and a half. The thing to keep in mind about troubled countries like Brazil, Indonesia, Turkey, maybe even the Philippines is this: The markets already know they have problems. So put your emotions aside. It’s precisely when it’s gone down 50%, 60% you should start to give a serious look at it. Anything is, at some price, a bargain, even though it’s not a prime asset.

The coming opportunity in health care

Part of the problem with health care is that there is a disconnect between providers and consumers. But more and more now, we’re starting to get more patient-oriented health care system.

You’re starting to see little signs of it already. For example, flu shots and walk-in clinics in drug stores.

Don't go with the crowd

You have to put your emotions aside and look at it cold. You can’t time these things, but there are huge opportunities out there, in terms of major breakthroughs in health care, medicine, technology—it’s a huge opportunity. Emerging markets are a mess right now. But wait for those 60% corrections, that’s when you move in. You can see it in biotech today—panic. That’s the time to move in, in my view. You don’t go with the crowd. You go against the crowd.

Editor’s note: The comments above are edited excerpts from a presentation Steve Forbes delivered in Chicago on May 2, 2014.

The information presented reflects the opinions of the speakers as May 5, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization, and are subject to change at any time based upon market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or fund is consistent with your investment objectives, risk tolerance, financial situation, and your evaluation of the investment option. Fidelity is not recommending or endorsing any particular investment option by mentioning it in this conference call or by making it available to its customers. This information is provided for educational purposes only, and you should bear in mind that laws of a particular state and your particular situation may affect this information.
Past performance is no guarantee of future results.
Foreign investments, especially those in emerging markets, involve greater risks and may offer greater potential returns than U.S. investments. These risks include the political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations.
Sector investments may involve greater volatility than more broadly diversified investments.
Lower-quality debt securities involve greater risk of default or price changes due to the credit quality of the issuer.
The S&P 500® and S&P are registered service marks of The McGraw-Hill Companies, Inc., and are licensed for use by Fidelity Distributors Corp. and its affiliates. The S&P 500 Index is an unmanaged market capitalization–weighted index of common stocks.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Prior to trading options, you must receive from Fidelity Investments a copy of “Characteristics and Risks of Standardized Options” and call 1-800-343-3548 to be approved for options trading. Supporting documentation for any claims, if appropriate, will be furnished upon request.
There are additional costs associated with options strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared to a single options trade.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
687298.1.0

Jurrien Timmer says that despite the appearance of calm on the surface of the markets, dramatic rotations are creating opportunities and causing challenges for investors. In his comments, he explains why he thinks the markets have been range-bound, and what investors may want to consider.

Opportunities beneath the surface

The S&P 500® Index began the year around 1,845, and five months later it has gone roughly nowhere. Still, it hasn’t been a smooth ride, with the stock index falling 6% in January and then rallying slightly to new all-time highs in March, and then falling and recovering again in recent weeks. On the surface, everything seems calm and volatility has been very low for almost every asset class, but underneath there have been big changes, especially with regards to sector and style rotation.

I think there are three reasons stocks have traded sideways for the past three months, and why they may well continue to do so for a number of months to come:

  1. The Fed: After six years of extraordinary monetary accommodation from the Fed, equities are finally pricing in the inevitability of rate normalization, however modest or gradual that might be.
  2. Valuations: Earnings growth has slowed into the single digits, and P/E ratios have risen into the high teens. That on its own does not have to be a deal breaker for stocks, but it comes on the heels of a huge 32% rally last year amid only 5% earnings growth. In fact, over the past five years, the S&P 500 has compounded at a 23% annualized growth rate. That’s a very impressive gain, and it creates the distinct possibility that U.S. equities are now in a secular bull market. But even secular bull markets need a pause now and then, and, after five years, I think that the combination of big gains and slowing earnings growth warrants a rest for the bulls.
  3. China: The economic model for China for the past decades has been to encourage small businesses and local governments to borrow money and build a lot of things. At the same time, the shadow banking system in China has promised savers high returns and has invested the proceeds in speculative loans, and so the total credit in the system has grown. But some of those loans are starting to go bad, and the credit cycle may be starting to peak. If your economy relies on credit growth and some of that credit goes toward rolling over bad loans, your growth is going to slow.

Trading the range

Both bonds and stocks have been moving in a range. Yields on the 10-year have been trading between roughly 2.5% and 3%. I don’t think yields can move much higher, thanks to low inflation and the likelihood that higher rates could hurt the economy. On the other hand, rates seem unlikely to go down too much, as a cycle of rising rates appears to be coming and the economy looks to be gaining strength. Meanwhile on the equity front, the S&P has been trading between roughly 1,750 and 1,900.

A trader could try to trade the range. Let’s say investors are worried about a slowdown, and the yield on the 10-year goes to 2.5%. Chances are that this same move will also cause the stock market to go down. So at the same time that it would make sense to sell the 10-year, it could makes sense to buy the S&P, because it’s probably going to be at the low end of its range. So it becomes a bond-to-stock trade. On the other end, if the market goes back up and the 10-year is at 3%, maybe at that point you buy the 10-year and sell the S&P. You could try these trades, but they’re singles, they’re not doubles, triples, or home runs, and you could argue that you are picking up pennies in front of a steamroller.

If we are in a range, then I think the better approach is to use sell-offs to upgrade. If there are stocks that you really love, and they go down for no good reason other than the fact that investors are selling stocks in general, then that could be an opportunity to buy the ones you like. And then, conversely, if there are stocks you no longer like and we are at the top of the trading range, then that’s an opportunity to sell them.

Rotations beneath the surface

In a market like this, money might not be made just by being long or by shorting the market, because the market’s going sideways, but rather by trying to take advantage of the major rotations taking place beneath the surface.

Last year, secular growth stocks performed well, but you had to pay up for that growth as price-to-earnings ratios expanded. This year, a shift into more defensive sectors has played out, with staples and utilities delivering better performance, while biotech, Internet, and financials have struggled. Traders may want to consider a defensive rotation, or exit open positions to raise cash to put to use during a downturn. At some point, this cycle could reverse, and then traders would look to play growth stories again.

At the same time, emerging markets have bounced after years of underperformance. These stocks are not thought of as value plays, but as a lot of money has left the emerging markets space, they became cheap. Recently, we have seen a rotation out of momentum stocks and into emerging markets. Ultimately, I don’t have much confidence that this recent uptick will be sustained, so traders may want to try to fade this rally.

The bottom line

The market appears to be stuck in a range, but that doesn’t mean there aren’t opportunities for traders to upgrade their portfolios or to try to take advantage of the changes happening beneath the surface.

The information presented reflects the opinions of the speakers as May 5, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization, and are subject to change at any time based upon market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or fund is consistent with your investment objectives, risk tolerance, financial situation, and your evaluation of the investment option. Fidelity is not recommending or endorsing any particular investment option by mentioning it in this conference call or by making it available to its customers. This information is provided for educational purposes only, and you should bear in mind that laws of a particular state and your particular situation may affect this information.
Past performance is no guarantee of future results.
Foreign investments, especially those in emerging markets, involve greater risks and may offer greater potential returns than U.S. investments. These risks include the political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations.
Sector investments may involve greater volatility than more broadly diversified investments.
Lower-quality debt securities involve greater risk of default or price changes due to the credit quality of the issuer.
The S&P 500® and S&P are registered service marks of The McGraw-Hill Companies, Inc., and are licensed for use by Fidelity Distributors Corp. and its affiliates. The S&P 500 Index is an unmanaged market capitalization–weighted index of common stocks.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Prior to trading options, you must receive from Fidelity Investments a copy of “Characteristics and Risks of Standardized Options” and call 1-800-343-3548 to be approved for options trading. Supporting documentation for any claims, if appropriate, will be furnished upon request.
There are additional costs associated with options strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared to a single options trade.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
687298.1.0

Following 2013's staircase-like move higher, the trading action thus far this year has been a bit more lateral. Marty Kearney, from the Chicago Board Options Exchange (CBOE), offers up a few options strategies that may be useful if sideways market action persists.

Selling puts

One strategy to consider in a sideways market is selling put options. You can sell calls and puts to generate income—including a variation of selling calls known as the covered call—yet selling puts is an interesting strategy if you’d like to generate income and you wouldn't mind purchasing the stock if it fell to a lower price.

Kearney: “People generally sell puts for two reasons. Number one: to generate income. Number two: to set a price—below the current market price—where they wouldn’t mind owning the shares. This is an income-generating strategy that can be especially beneficial for investors who may have missed a stock’s move up and wouldn’t mind buying it if it came down a bit. Plus, if the price doesn’t fall and you don’t get the stock, the consolation prize is the cash from selling the option.

“Let’s look at an example. Suppose a stock that you do not own is trading at $50, but you wouldn't mind buying it if it went down 10% (to $45). If you wanted to own the stock, you could put in a bid at $45 to potentially buy 100 shares. Alternatively, you could sell the 45 strike price put, with no protection (known as a naked put). Here, if you did sell the 45 put, you would have an obligation to buy the stock at $45 if the option were exercised. However, let’s say you collect $1 in premium. In this example, if the stock doesn't get to $45, you get to keep $100 ($1 premium times 100 shares for the put option contract). If it goes below $45—which is the point at which you may want to own it—you are buying it at $45. But remember, you collected $1 for selling the option. So, you are effectively buying the stock at $44."

Note that this is a naked put, and Fidelity customers will have to meet the appropriate margin requirement.

Covered call

Another income-generating strategy that involves selling options is the covered call. Now, investors can use the covered call strategy at any time, rather than just when there’s sideways market action. Nevertheless, Kearney suggests covered calls may be particularly useful in markets like these.

Kearney: “The premise of a covered call is, you own shares of stock, and you’re selling a call on the same stock. One advantage of owning the stock of an option you are selling against is that there’s no margin, because you have the shares as collateral. If the stock doesn’t move, which it might not in a sideways moving market, you get to keep the premium.

“If the stock goes above the strike price you choose, you may have to deliver the stock. But this is a relatively conservative options strategy. You can even do this in a retirement account at Fidelity.”

Iron Condor

Selling puts and covered calls are relatively straightforward strategies that, with a little practice, most investors should be able to learn. The iron condor is a more complex strategy, for the advanced options trader.

To construct an iron condor trade, you create two credit spreads—one above the current market price and one below. The purpose is to take in cash from both credit spreads under the assumption that the stock won’t move much in either direction and that all the options will thus expire worthless. Kearney says that because of how the iron condor is constructed, it can be an attractive strategy for a sideways market.

Kearney: “An iron condor is a credit spread strategy: You take in income at the outset. Let’s look at an example of a stock that is currently trading at $50 to illustrate how you might construct this position. First, you might be interested in selling a call with a 55 strike price on a stock you don’t own and don’t think will go higher. In order to reduce the margin associated with this trade, you might decide to buy a 60 strike price call, which creates a credit spread.

“As long as the stock doesn’t go above 55, you are in great shape. If it does go above that price, you may lose money on the trade. But at least you know your risk is limited if it goes to, say, 70 or 80, because you purchased that 60 strike price call for protection.

“In addition to this spread, you might sell the 45 strike price put and buy a 40 strike price put to complete the iron condor. Thus, if you sell a 55 call and a 45 put, the stock could move 10% in either direction and you still get to keep the income created by both credit spreads, because those options expire worthless. Plus, you have protection from sharp moves in either direction due to the options you purchased in each credit spread. But remember, in a sideways market, you are expecting the market, or a specific stock, not to move that much. Consequently, this may be an appropriate strategy for that type of market.”

The information presented reflects the opinions of the speakers as May 5, 2014. These opinions do not necessarily represent the views of Fidelity or any other person in the Fidelity organization, and are subject to change at any time based upon market or other conditions. Fidelity disclaims any responsibility to update such views. These views may not be relied on as investment advice and, because investment decisions for a Fidelity fund are based on numerous factors, may not be relied on as an indication of trading intent on behalf of any Fidelity fund.
As with all your investments through Fidelity, you must make your own determination whether an investment in any particular security or fund is consistent with your investment objectives, risk tolerance, financial situation, and your evaluation of the investment option. Fidelity is not recommending or endorsing any particular investment option by mentioning it in this conference call or by making it available to its customers. This information is provided for educational purposes only, and you should bear in mind that laws of a particular state and your particular situation may affect this information.
Past performance is no guarantee of future results.
Foreign investments, especially those in emerging markets, involve greater risks and may offer greater potential returns than U.S. investments. These risks include the political and economic uncertainties of foreign countries, as well as the risk of currency fluctuations.
Sector investments may involve greater volatility than more broadly diversified investments.
Lower-quality debt securities involve greater risk of default or price changes due to the credit quality of the issuer.
The S&P 500® and S&P are registered service marks of The McGraw-Hill Companies, Inc., and are licensed for use by Fidelity Distributors Corp. and its affiliates. The S&P 500 Index is an unmanaged market capitalization–weighted index of common stocks.
Options trading entails significant risk and is not appropriate for all investors. Certain complex options strategies carry additional risk. Prior to trading options, you must receive from Fidelity Investments a copy of “Characteristics and Risks of Standardized Options” and call 1-800-343-3548 to be approved for options trading. Supporting documentation for any claims, if appropriate, will be furnished upon request.
There are additional costs associated with options strategies that call for multiple purchases and sales of options, such as spreads, straddles, and collars, as compared to a single options trade.
Fidelity Brokerage Services LLC, Member NYSE, SIPC, 900 Salem Street, Smithfield, RI 02917
687298.1.0