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Can Traders and Investors Avoid the Fiscal Cliff?

Headlines in financial media are now dominated by the fiscal cliff. While the year-end deadline is no small obstacle, excessive noise coming from Washington can turn any investor into a nervous

Headlines in financial media are now dominated by the fiscal cliff. While the year-end deadline is no small obstacle, excessive noise coming from Washington can turn any investor into a nervous wreck. Can investors afford to ignore the political jockeying by lawmakers on Capitol Hill?

In this week’s interview, asks Toni Turner of TrendStar Trading Group for her thoughts on approaching the fiscal cliff, and if there is anything traders and investors can do to better position themselves from the possible fallout.

EQ: There hasn’t been much progress coming out of Washington in terms of resolving the fiscal cliff. Yet, the market had been slowly inching higher last week. Are stocks more optimistic than we think?

Turner: In going through the charts of many of the indices like the S&P 500, S&P 400 and the NASDAQ this past Friday, I saw that many stocks–even though the market itself was flat on the day—were breaking higher and even closing on relative new highs. So yes, some stocks have ignored Washington’s posturing and are marching to the beat of their own drums. That said, many sectors are overbought in the short term and as of this Monday, I see signs that quite a few sectors and industry groups, as well as the stocks in them, do look as though they may  retrace here.

EQ: We saw some slight movements last week directed by what were essentially inconsequential comments from lawmakers. How sensitive is the market right now to impactful news regarding the fiscal cliff?

Turner: This is definitely a Capitol Hill headline-driven market. The ISM numbers came in a bit weaker than expected, and the market simply took a quick gulp of the current economic numbers, digested them quickly, and then turned back to the fiscal cliff and any comments from lawmakers  in Washington. Right now, rumors abound. Some are saying that President Obama is fine with going over the fiscal cliff. Others are declaring that the GOP will permit that as well. I believe right now, as I look at this market, that it is getting disgruntled.

I think the market is getting tired of all this and wants a resolution, but I don’t know if there’s going to be one before the end of the year. So if you combine that with the fact that the market is overbought for the short term, we could have a retracement here.

EQ: For long-term investors that would prefer to ignore the immediate noise coming out of Washington, would you suggest exploring short-term hedges during this time?

Turner: There are ways to hedge, but unfortunately, many of the new ways to hedge that have are best left in the hands of experienced, short-term traders. Many investors are looking to hedge by buying the Chicago Board Options Exchange Market Volatility Index (^VIX), which is also known as the fear indicator. You can buy the iPath S&P 500 VIX ST Futures ETN (VXX) or the iPath S&P 500 VIX MT Futures ETN (VXZ), or even the Ranger Equity Bear ETF (HDGE)—and hedge with those particular ETFs. However, you have to take great care with them because they are not designed to be long-term holds. They should only be held for short periods, say one to three days. it’s very unwise for investors to get into these contrarian funds if they don’t know the risks.  These vehicles can be very different from what people think they are.

Of course, one way to hedge is to just stand on the sidelines and not take any new positions. Investors can also always go into bonds or related ETFs such as the iShares Barclays 20+ Year Treas Bond (TLT) or the iShares Barclays 7-10 Year Treasury (IEF), which are always considered as safe havens.

I know a lot of investors may think they should be buying some of the inverse ETFs like the ProShares Short Dow30 (DOG), which is the inverse of the Dow. That’s fine, but again, I would caution against holding any inverse  ETF for an extended length of time. The inverse leveraged funds, especially, can be real widow makers because most investors don’t know how they’re constructed.

EQ: We discussed Utilities last week as a sector to watch. How is that group doing? Are there any specific sectors or groups that are holding your attention this week?

Turner: Utilities are looking good. They have bounced off what appears to be a tradable low. The Utilities Select Sector SPDR (XLU) is holding right now in a down market and is actually consolidating pretty nicely. So that remains to be a place I’m watching. I’m also watching the iShares Dow Jones US Telecom (IYZ), which is on a pullback so it may need to either consolidate or pull in a little bit here before I consider it as a long position. The Financial Select Sector SPDR (XLF) is another one I’m watching. Typically in good times, Financials will do well in January, however, the XLF right now is trading around the mid-$15s. It has to move up to the $16 zone for it to look more positive, but there is quite a bit of resistance at that level. If it can’t do that, then the pattern that it’s in right now is what we call a throwback rally. If it starts heading lower on negative news out of Washington,  then it may actually be a good time to sell it short.

As the markets put the debt ceiling debacle in the rearview mirror, more than a few issues remain open.