Three ways to profit from the taper tempest

Mon Sep 23, 2013 4:29pm EDT

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013. REUTERS/Jonathan Ernst

The facade of the U.S. Federal Reserve building is reflected on wet marble during the early morning hours in Washington, July 31, 2013.

Credit: Reuters/Jonathan Ernst

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(The author is a Reuters columnist. The opinions expressed are his / her own.)

By John Wasik

CHICAGO (Reuters) - After the Federal Reserve's revelation last week that it would not be trimming its bond-buying stimulus program, the storm clouds menacing the stock and bond markets parted.

Investors in both markets relish the idead of cheap money keeping financing rates low. The Fed has been buying Treasury securities at the rate of $85 billion a month to keep interest rates low and stimulate the economy.

U.S. stock market indexes hit all-time highs on September 18 in the wake of the Fed's announcement, followed by gains on overseas exchanges the following day. The Standard & Poor's 500-stock index is up almost 22 percent year to date through September 20. Bond prices have also recovered, as yields fell from the 3 percent range in recent weeks to about 2.74 percent. As yields fall, bond prices rise.

Here are three moves that make sense as the Fed continues its policy.

1. Buy U.S. stocks.

A combination of healthy U.S. corporate profits, a recovering economy and low interest rates is feeding the bull market in stocks, which most analysts expect will continue through the end of the year. Profits are expected to rise about 6 percent this year, on average, according to Thomson Reuters, which gives stock prices some more room to grow.

A broad-based U.S. stock fund such as the Vanguard Total Market Index ETF represents most U.S. stocks. It's a worthy core vehicle that holds large-, medium- and small-capitalization companies. If you need growth in your portfolio and have retreated from stocks, it's still a good time to consider this index fund. The annual expenses are 0.05 percent annually, so it's a bargain. The fund has gained 21 percent for the year through September 20.

Even rising interest rates may not clip the wings of the stock rally. According to a recent S&P Dow Jones Indices report, "rising rates have clearly not been bad for stocks over the last two decades. In three rising-rate periods since 1993, the S&P 500 Index gained an average monthly return of 0.96 percent, compared with 0.82 percent during falling-rate periods."

2. Go abroad for diversification.

Picking non-U.S. stocks has not been easy during the past few years. Europe is on the slow road to recovery, and the developing countries of Brazil, China and India have been gearing down. And when reports of the Fed backing off its stimulus plan emerged, stocks from developing countries were bruised.

The Fed's announcement that it will continue its bond-buying program is good news for non-U.S. stocks. While developing-country stock returns have been lackluster, they are still worth holding for diversification.

The iShares MSCI Emerging Markets ETF tracks an index that holds Samsung Electronics Co. Ltd., China Mobile Ltd. OAO Gazprom and other companies in developing countries. The fund is up nearly 3 percent for the year through September 20 and charges 0.69 percent annually.

3. Re-allocate your income portfolio.

What if you still need income but are not convinced rates will stay low? The worst thing you could do is to bulk up on high-yield vehicles with intermediate- to long-term maturities.

Let's say you like the extra yield that corporate bonds provide over U.S. Treasury bonds, but you don't want to take the kind of risk associated with longer-maturity funds. The SPDR Barclays Capital Short-Term Corporate Bond ETF might be the answer.

The SPDR ETF tracks an index that represents corporate bonds with maturities from one to three years. Currently, the fund yields just north of 1 percent and has returned 1 percent for the year through September 20. The fund's managers charge 0.12 percent for annual expenses. It's yielding about 1 percent.

At the least, be prepared for rising rates with vehicles that track them on the upside without hurting your principal. The iShares Floating Rate Bond ETF tracks an index of floating-rate notes. The fund yields just under 1 percent and charges 0.20 percent for annual expenses.

Another vehicle that can track higher rates is a senior loan fund, which holds notes made to companies with lower-quality credit ratings. The trade-off for the higher risk is higher yield. The PowerShares Senior Loan Portfolio ETF offers a 4 percent yield and charges 0.66 percent annually.

One warning: My optimism fades in a heartbeat if Congress doesn't act on raising the U.S. debt ceiling. That would trigger a default on U.S. obligations - and sideswipe the rosy scenario for the stock and bond markets.

Once again, Wall Street will be looking toward Washington to see how ominous the clouds on the horizon look.

(Revises first sentence of second paragraph to change wording from "cheap money continuing to fill the coffers of banks and corporations" to "cheap money keeping financing rates low.")

(Follow us @ReutersMoney or here Editing by Lauren Young and Douglas Royalty)

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