When a pullback happens, you need to be prepared.
That statement might ring hollow considering the fact that the market is bumping up against all-time highs, but I can assure you, it could happen quicker than you think. When it does, you'll want to have enough cash on hand to pick up some bargains.
You'll also want to have your own "pullback wish list."
To assist in that pursuit, I asked StreetAuthority's top stock market strategists to name the first one of their portfolio holdings they would buy more of if prices suddenly "corrected" by 10%. (You can read Part 1 here and Part 2 here.)
Here's what they had to say:
My two advisories are the only ones in the StreetAuthority lineup that are geared toward one narrow sector of the market: natural resources. That means I'm probably keying on different economic and industry data points than my colleagues.
I stay tuned in to things like employment and consumer spending, of course, but I'm more interested in reports that illuminate current trends in the commodities world -- such as crop estimates, copper production and natural gas stockpiles. I spent most of my morning today evaluating Australia's iron ore exports.
As always, I'll be paying particular attention to China, which exerts considerable influence over commodity prices. China's economic health can literally mean the difference between shortfall and surplus for many raw materials, so I stay glued to the country's monetary policy, infrastructure spending, manufacturing output and other factors.
As we head into the summer months, my biggest areas of emphasis will be in the aerospace and auto sectors -- not because I've invested in plane and vehicle makers, but because many of my holdings are predicated on their success. Earlier this week, Turkish Airlines placed a $6.9 billion order for 70 Boeing (NYSE: BA) jets. Few people noticed. But I'm celebrating, because much of that $6.9 billion will be spent on raw materials like aluminum and cobalt and titanium alloys -- that's good news for a number of my holdings.
The first stock I would buy on a pullback? Linn Energy (Nasdaq: LINE), the most conservatively managed company I know of. If Linn were to get swept along with a sell-off in the broad market, then investors just aren't paying attention.
The firm's protective hedging has almost completely shielded cash flows from a downturn in commodities prices -- every cubic foot of gas and drop of oil have been presold through 2016 at minimum floor prices.
That enables the company to practically print money for stockholders, even in a rough environment. And when oil and gas prices rebound, Linn can easily turn up the production faucet, with 7,000 potential new drilling locations spread over 3.2 million acres.
There are many ways for a stock market to correct. One is simply to go sideways for a long period of time. During this type of environment, income stocks that provide a robust yield well above the rate of inflation make a sensible investment. Even if the overall market corrects by retreating, a solid income stock should hold its value relatively well and rebound when the overall market recovers.
And when I think of solid income stocks, Enterprise Products Partners (NYSE: EPD) is at the top of my list. This is one of the largest publicly traded energy partnership in the United States. It operates more than 50,000 miles of pipelines, enough to circle the Earth twice. These pipelines are connected to around 95% of the country's refining capacity east of the Rockies.
Enterprise has an exceptional dividend track record. Management has hiked the distribution every quarter since January 2005, when it was $0.40 a quarter, or $1.60 per year. The latest January distribution has grown to $0.66 per unit, which translates to $2.64 annually, for a compound annual growth rate of 6% per year. And the April distribution, which was announced on Tuesday, will be $0.67 a share -- the 35th consecutive increase.
With a yield of 4.5%, EPD is one of my top picks, and a stock I would consider buying more of on a pullback.
Volatility is the most important indicator for me to watch. I monitor volatility on the stock market using indexes like the VIX and on individual stocks using an indicator I developed to mirror the VIX and expand the idea to the thousands of stocks that trade options.
When prices fall, volatility rises. This is true for individual stocks and the market in general. Since most stocks follow the general trend of the market, a sell-off would increase volatility in many of the stocks I'm watching and create a number of income trading opportunities using options.
Options prices are determined by a number of factors, but volatility is the most important factor. Other factors include the amount of time to expiration of the options contract and interest rates, items that change slowly. Volatility can change in minutes and could drive options prices much higher or lower when they do. That's great for options sellers, because we generate more income when options are expensive.
Sometimes, the options market gets a little crazy, and the prices we see are much higher than expected based on pricing models. When that happens in value stocks, we have an exceptional trading opportunity. In other words, a sell-off would create many opportunities to generate large amounts of income selling options.
While I'd welcome a market sell-off because it will create some mispriced options, I don't know which stocks will be the best to trade until the decline happens. That's why my advisory, Income Trader, is published weekly. There are thousands of stocks and a variety of different options contracts on those stocks. On a recent day, my software ran through more than 175,000 different options contracts to find trading candidates. A market decline, especially a quick one, would give me a chance to trade a lot of those contracts.