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Summer Time: Easy Living? Or the Perfect Storm for Your Stocks?

NEW YORK (TheStreet) -- The summer solstice of 2014 marked a record low in volatility (VIX). Meanwhile, valuations are hitting new highs (for this cycle), the economy is accelerating, interest rates are at record lows and corporate balance sheets are cash rich. It's summer time, and the living is easy ... right?

Or, is it the calm before the storm? Beneath these apparently smooth waters lie some very dangerous risks, risks big enough to sink even the most 'Titanic' and unsinkable of investment funds.

Rising interest rates are not far off. Federal Reserve Chair Janet Yellen has set a course for the Fed which includes the end of QE3 in 2014 and a rising federal funds rate in 2015 and 2016. Dramatic changes in her 3-year to 5-year plan are unlikely, as they would cast doubt on her self-confidence, on the Fed's integrity as an institution and on the reliability of the capital markets in general. Meanwhile, there is a steady drumbeat of increased inflationary pressures right now which suggests that the Fed may be behind the curve on inflation.

Even more dangerous and unpredictable, however, is the fast-changing situation in the Middle East and its impact on oil prices, which have already risen 10% in response to the civil wars in Syria and Iraq. The war in Iraq threatens more than 2,000,000 barrels per day of oil production without which, experts predict, global oil prices are headed to the $150 per barrel to $200 per barrel per day range. Not even the mighty American consumer is immune to such a dramatic increase in oil prices. Indeed, if such price levels last for an extended period of time, then a global recession is likely to follow.

To complete the perfect storm of uncertainty in the stock market, the entire U.S. House of Representatives and one-third of our Senate are up for grabs in the November elections. Policy options ranging from long term U.S. military occupation of Iraq and Syria to complete military isolationism with acceleration of federal investment in alternative energies (and everything in between) are on the table in this election.

Given the seriousness of these risks, and more importantly the great uncertainties that they present to investors around the world, it seems more likely than not that the capital markets will drift, if not decline this summer as investors sit on the sidelines and await greater certainty about how these important questions will play out. Uncertainty, after all, is the greatest of all investing risks.

Bonds don't offer much of a safe haven this summer, either. Given the Fed's schedule of rate increases, the bubbling up of inflationary pressures, the end of QE3, and the high likelihood of continued U.S. budget deficits (some things are more certain than others); the long end of the yield curve is highly vulnerable to a significant price decline (rise in yields).

That leaves only non-interest-rate-sensitive, defensive equity sectors -- healthcare & staples -- and cash as the only safe havens for the summer of 2014. Gold may catch a safe haven bid and/or an inflationary bid. And, with inflation heading higher, there may also be some opportunity in certain raw materials stocks over the summer of 2014 and the rest of the year.

Of course, good stock picking always carries the day (and the month, the quarter, the year, the decade). It's always a stock picker's market; and valuations always matter. There is no substitute for homework on individual stocks.

This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.

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