Where is this market going in the foreseeable future?
The answer is: nowhere.
Rarely have there been such powerful forces preventing the market from going much higher or much lower.
First, let's take a look at headwinds against the market going too high.
A main catalyst here is Europe. Unless the European crisis explodes into a full blown financial crisis, there will still be an overhang of worry for some time to come. Simply put, in the absence of another financial crisis, the threat of one should continue to limit the market's upside.
Also, a powerful ceiling has also been created by commodity prices and inflation.
As economic activity picks up and the economy starts to gain traction, commodity prices start to spoil things. Commodity inflation can be tracked using the Continuous Commodity Index, a recognized bellwether for commodity prices in general (including oil, grains, metal, livestock etc.) that consists of 17 different major commodities.
The index rallied to a high of over 600 in 2008 only to fall all the way to less than 350 during the financial crisis. As economies recovered from the recession, the index crept up to a new high of almost 700 this past April. As the economy sputtered last spring, the index fell to 565 but has since recovered back to 600 as economic news has somewhat improved.
The point is that every time the economy gains traction, commodities prices move higher and detract from the recovery. This is most notable with oil prices.
Crude oil climbed from a financial crisis low of about $35 per barrel to $113 this past spring. Crude oil then fell to below $80 in September and is now climbing back towards $100 per barrel. While lower fuel prices help the economy when it sputters, the rising prices eventually hinder growth as it starts to recover.
The transportation oriented global economy is forced to absorb higher prices and input costs which are difficult to pass on to the consumer in a competitive environment. Absorbing higher costs takes up valuable resources for companies to expand and hire people, thus inhibiting economic growth.
But, the good news is that there are forces also limiting the downside.
While a crisis in Europe or some other unforeseen crisis could send markets plunging, stocks prices should hold up in the absence of disaster. The most notable reason is the fact that money really has no place else to go. The 10-year Treasury is paying 1.97 percent and a three year CD pays just 1.07 percent. As fear of crisis wanes, money flees safe heaven investment and gravitates toward the stock market.
Since recovering from the financial crisis, the Dow Jones Industrial Average has ranged between about 12,800 and 10,800. But, the range has not been boring. It has been remarkably volatile. The 66 trading days since August 1st have witnessed 51 days of 100 point plus swings and 10 days with moves of more than 300 points. The market has moved sideways in a violent manner.
This volatile sideways movement presents opportunity.
Dividend stocks in particular provide value because investors continue to get income even if the market goes nowhere. The volatility creates the opportunity to buy these dividend payers on market dips where the prices are lower and the yields are higher. Another opportunity is for covered call writing.
Selling a call against a stock position enables investors to generate an extra income from the call premium. It essentially involves earning a higher income at the expense of potential capital appreciation. The strategy is particularly well suited for flat markets because it enables investors to generate additional return. As well, market volatility generally increases the price of call premiums, making the strategy even more effective.
If you don't want to undertake writing covered calls on your own, there are several funds and ETFs that implement the strategy. One solid fund is Blackrock Enhanced Capital and Income Fund (NYSE: CII). This closed-end fund seeks to provide a high level of current income by writing covered calls on approximately 60 percent to 70 percent of a diversified portfolio of primarily large capitalization value domestic stocks.
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