What to Expect When You're Expecting a Correction

NEW YORK (TheStreet) -- For whatever reason, it feels like the collective guard is up in the investment community.

We have Russian/Ukrainian tension, the stock market seems to be bumping up unsuccessfully against resistance, and nobody can seem to explain why Treasury yields are dropping despite the Fed tapering and a strengthening US economy. We outlined the reasons for this counter-intuitive phenomenon a few months back.

We have heard cynical market pundits like Nouriel Roubini and Marc Faber calling for a market crash ever since, well....the last crash. This impending crash has simply not materialized. But is it time to prepare for a correction, at least?

We have recently been trimming our exposure to U.S. stocks, in spite of all the good news. After all, it was in the face of primarily bad news -- and the accompanying Federal Reserve steroid injections -- that we moved steadily higher over the past five years. There is also the camp that says the end of Quantitative Easing will be bullish for stocks, and that finally the bond market and interest rates can return to "normalcy."

We are now about halfway through the Fed's tapering, and I'd say results have been both mixed and unexpected.

Tuesday felt like the beginnings of a correction as the S&P 500 lost nearly 1%. But international, as seen in the Vanguard FTSE All-World ex-US ETF (VEU), and emerging markets, seen in the Vanguard FTSE Emerging Markets ETF (VWO), were both in positive territory, albeit slightly....

VEU Chart

I happen to think conditions are excellent for stocks. Interest rates are low, central banks the world over are coordinating efforts and momentum is clearly working in their favor. I love stocks. But I also know what greed smells like, and we are starting to catch a whiff in conversations with clients.



Taking a step back, U.S. markets have had an incredible run but they're no longer cheap. It wouldn't surprise me if the market ends the year higher than where we are now, but with a great deal of volatility in the interim.

Broken Record

I'm going to sound like a little bit of a broken record but I think you want to stick with those asset classes that provide steady cash flow: real estate investment trusts and master limited partnerships are two good examples. I think buying long-term Treasury Bonds (iShares Barclays 20+ Yr Treas.Bond (TLT)) is an okay place to park some cash for a short period of time, keeping in mind that this should be viewed as a trade only.

The 30-year Treasury currently sits below its 10-, 50-, and 200-day moving average and, whether it makes sense or not, the trend is firmly down. The drop in yield won't continue in perpetuity, but it's certainly possible there is more downside than upside in yield -- and therefore more upside than downside in price -- for the duration of 2014. 

30 Year Treasury Rate Chart

There are no guarantees that we will experience a correction of any consequence in the coming weeks or months, but the ingredients are all in place and we're happy protecting our clients' capital at this point.

When looking for opportunities in what could be choppy waters ahead, the options vary depending on your risk tolerance. If you already own some of the aforementioned assets -- REITs (Vanguard REIT ETF (VNQ)) or long-dated Treasury bonds -- consider increasing those position sizes, while trimming U.S. equity exposure.

Within the MLP space some selectivity is required, as many of these names and even the index (JPMorgan Alerian MLP (AMJ)) have gotten a little rich. It's a good time to add to a few names we've mentioned before: AmeriGas Partners (APU), Kinder Morgan Energy Partners (KMP), MarkWest Energy Partners (MWE) and Williams Partners (WPZ). Each has a great deal of yield support and track record of maintaining if not increasing its distribution over time -- these should trade well, especially if rates continue to move lower.

If volatility doesn't bother you, or if the tax implications of rebalancing are too much, you may not want to do anything at all. A middle-of-the-road solution might be to take some of your U.S. equity chips off the table and hold some cash for a bit. It's highly likely you will see these same prices, if not better, again in the future.

At the time of publication the author was long APU, KMP, MWE, TLT, VEU, VNQ, VWO, and WPZ.

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

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