Mixed Picture Calls For Diversification And Flexibility

The S&P 500 closed at 1,848 on December 31, 2013. Fast forward 125 days and not much has changed. The S&P 500 was projected to open at 1,873 Monday morning. The number of inputs causing investors to pause in 2014 is almost unlimited, but we can zero in on the three below fairly easily.

Economy + Taper + Ukraine = Tenative Stock Market

Catastrophic Consequences

Money managers are comfortable making decisions based on the economy, earnings, and the Fed. They are not nearly as comfortable trying to factor in an almost unlimited number of possible outcomes in the Ukraine/Russian conflict. The news early Monday did not inspire confidence that this issue is close to a resolution. From CNBC:

Troubles in the Ukraine continued to spook markets, with most European bourses down over 1 percent as Russia warned Ukraine of "catastrophic consequences" unless it halted a military operation against pro-Russian rebels. Clashes broke out in six cities in eastern Ukraine over the weekend, as pro-Russian forces stormed a police station in Odessa, freeing close to 70 activists that were being held there. This followed the death of 46 people in the conflict on Friday, marking the bloodiest day since the ousting of former Ukraine president Viktor Yanukovich in February.

Strategies For A 60/40 Market

This week's stock market video covers strategies for approaching a still slightly bullish, but concerning risk profile for stocks.

Numbers Below 50 Indicate Contraction

We have already established the news greeting investors on the Ukraine/Russia front is less than desirable. It was not much better on the economic front. Money managers have been fearful of slowing growth in emerging markets. Data from China late Sunday night did nothing to alleviate those fears. From Bloomberg:

China's manufacturing contracted for a fourth month in April, according to a private survey that missed estimates and sent stocks in the region lower on concern the economy's slowdown is deepening. A purchasing managers' index was at 48.1, HSBC Holdings Plc and Markit Economics said in a statement today. That compared with a 48.4 median estimate from analysts surveyed by Bloomberg News, a preliminary reading of 48.3 and March's 48. Numbers below 50 indicate contraction.

Bonds: Supply and Demand

As noted in the video above, offsetting equity risk with complementary stakes in bonds and money markets is one way to approach tentative markets. Last week, we highlighted that long-term Treasuries (TLT) are sending some "be careful" signals regarding a migration to more stable investment options. The longer end of the treasury market is also benefiting from the law of supply and demand. From Bloomberg:

In a world awash with U.S. government bonds, buyers of the longest-term Treasuries are facing a potential shortage of supply. Excluding those held by the Federal Reserve, Treasuries due in 10 years or more account for just 5 percent of the $12.1 trillion market for U.S. debt. New rules designed to plug shortfalls at pension funds may now triple their purchases of longer-dated Treasuries, creating $300 billion in extra demand over the next two years that would equal almost half the $642 billion outstanding, Bank of Nova Scotia estimates. Fewer available bonds, along with a lack of inflation and increased foreign buying, help to explain why longer-term Treasuries are surging this year even as the Fed pares its own bond purchases. The demand has pushed down yields on 30-year government debt by more than a half-percentage point to 3.37 percent, the most since 2000, data compiled by Bloomberg show.

Investment Implications

Our market model is an economic conviction model. When investors have a high degree of conviction relative to an asset class, region of the globe, or individual country, the odds of investment success are more favorable. Indecisive or confused markets create a less favorable investment landscape since conviction is non-existent. Currently, investors are not particularly confident about holding stocks, nor are they overly excited about the fear trade. Therefore, our mix of stocks (SPY), bonds, and cash remains prudent until conviction surfaces in some corner of the investment universe.