Trading Opportunity In High Quality Stocks

Despite a weakening global economy and a lackluster corporate earnings season, the U.S. stock market has been in rally mode ever since the European Central Bank completed its latest meeting on monetary policy late last week.  Although ECB Chairman Mario Draghi did not deliver a new stimulus program that so many in the market had been anticipating, the mere suggestion that something was likely to be implemented in the coming weeks has been enough to help send the S&P 500 Index higher in each of the last six trading days.

What has been most notable about this most recent stock market advance has been its composition.  In short, it has been a “garbage” rally.  In other words, the companies that rank among the lowest in terms of quality and highest in terms of stock price volatility have been the almost exclusive drivers of the advance.  Overall, these stocks have gained nearly +5% in the past week as measured by the S&P 500 High Beta Index.  Conversely, the companies that rank among the highest quality and lowest price volatility have hardly participated at all.  In fact, these stocks are collectively lower by roughly -0.5% over the past week as measured by the S&P 500 Low Volatility Index.

If we indeed see additional stimulus from the ECB or the U.S. Federal Reserve, the fact that lower quality higher beta stocks are leading the market thus far does not come as a surprise, as they are the typical leaders in the very early stages of these types of rallies since they are usually the same stocks that were sold off the most during any prior sell off.  But it does not take long for the higher quality low volatility stocks to begin accelerating in their own right to begin closing the initial performance gap.

This is the basis of the trading opportunity currently associated with high quality low volatility stocks.  They have yet to participate in the recent rally, but if it continues to look increasingly probable that the major central banks will end up delivering more stimulus as anticipated, these higher quality stocks will begin advancing to close the performance gap.  However, if it turns out that central banks fall short of the market’s stimulus expectations, high quality stocks will benefit from the downside protection not only from the fact that they have yet to move higher on stimulus hopes to this point but also from their inherently more defensive characteristics.

A position in the S&P 500 Low Volatility ETF (SPLV) was initiated on August 10 with the design to capitalize on this potential trading opportunity.  And depending how events unfold in the coming months, this position is also viewed as a potential longer term holding to potentially provide continued lower risk equity exposure in various market scenarios.

This post is for information purposes only. There are risks involved with investing including loss of principal. Gerring Wealth Management (GWM) makes no explicit or implicit guarantee with respect to performance or the outcome of any investment or projections made by GWM. There is no guarantee that the goals of the strategies discussed by GWM will be met.


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