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Risk and return. It's a familiar investing concept. The more risk an investor takes with their money, the more return available. Right? Not so fast.

Don't be fooled so easily.

The current financial world is heavily managed, more so than ever. Monetary authorities have reset that risk-return tradeoff in novel ways. Today's commentary will help you learn more about this 3 step ladder to risk and, better yet, how to profit from it.


Here's How it Works

At the bottom of the risk ladder, Central Banks smash safe haven bond returns to zero, and offer negative yields on deposits. That forces risk taking upon banks, investment funds, and traders alike.

At the middle of the risk ladder, a recent rally in high yield bond credit spreads encourages risk taking. This stirs up buyers for the S&P500.

At the top of the risk ladder lie truer 'Risk-On' investment plays -- small caps and international stocks. International stocks saw bear markets the last 2 years. The Russell 2000 went sideways. Both trade up in a Bullish valuation recovery now.

Where are we now?

The old Bullish saying was "Don't Fight the Fed". The new Bullish saying is "Don't Fight the Central Banks of Every Advanced Country!"

How can you profit in this environment? Read on!

Continued . . .


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Bull Market Deadline Nears

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It names 4 key trades with tremendous upside to make the most of this movement, and Weekend Wisdom readers are welcome to access them right now for free.

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The Bottom of the Risk Ladder-- Fixed Income Cupboard is Bare

It's a fait accompli. Across advanced countries, central banks keep policy rates near zero. The Fed announced its plan to slightly raise rates.

See below:



The fixed income cupboard is barren. An unprecedented amount of quantitative long-term bond buying (from the Fed, BoE, ECB, and BoJ) has been applied too.

In 2016, central bank actions haven't stopped at zero rates and QE. There are also negative deposit rates on accounts at Central Banks to discuss (Sweden's Riksbank, Europe's ECB, and the BoJ). According to JP Morgan International, approximately 25% of its government bond index is in negative territory. More important, the size of this market has grown dramatically from zero in mid-2014 to more than US$6 trillion.

In lieu of near zero risk-free return, investors chase riskier fixed-income yield in corporate investment grade bonds, high yield bonds, or sovereign debt.

The other quasi fixed income alternative is dividend-paying stocks. That’s bullish! Prices of defensive stocks have been bid up in an intense search for yield.


The Middle of the Risk Ladder -- Oil Prices, Energy Stocks, and HY Bond Spreads

There is a fresh Energy sector EPS dynamic afoot for Bulls. Analysts believe Q1 2016 will mark the bottom both in terms of year-over-year declines in earnings for the S&P500 Energy sector and in terms of the average price of a barrel of oil.

What you also need to understand is incorporated in the following chart.



This chart shows a 9.0% high yield bond credit spread was reached early in 2016 just as the WTI oil price collapsed to $26 a barrel. For months, High Yield Bond credit spreads tied to the finance of Oil, Industrial, and Materials companies had blown out. Note the last time these bonds reached the 9.0% credit spread level. It was back in 2011 during the first European debt crisis. A three-year bull market for stocks ensued, riding along with the decline in high yield credit spreads in the BofA Merrill Lynch index to below 4.0% in 2014.

I finish this point with caution. Note periods of reversal, where high yield credit spreads temporarily move higher. It is not a smooth process of adjustment.


The Top of the Risk Ladder -- Risk-On! Small Caps, and International Stocks

Small cap indices have staggered around, moving sideways for 2 years. If tracking of total nonfarm payroll matters -- this serves to proxy for the U.S. economy -- the latest Russell 2000 price stall undervalues them by >20%.

The Russell 2000 (in blue) prices at 2800 in the chart below. Getting to a macro level even with the total U.S. non-farm payroll line (in red) means a Russell 2000 move to 3400 or more.



'The only stock index that matters right now is the Russell 2000. And it finished the [Friday April 22nd] session up +0.96% and the week up +1.9%."
– Tracey Ryniec, Zacks Senior Value Stock Strategist


Conclusion

Keep share-buying logic simple. For two years, share buying concentrated on the less risky middle rungs on the risk ladder. From a growth and value perspective, this stranded the highest stock returns towards the top. I don't see how this expansion cycle ends before an exuberant oomph to chase them down. The economy and/or financial markets need to see real excesses first, before a meaningful downturn is required to fix them. We haven't seen that yet.


What to Do Now?

First step is to see the full case for a continuing bull market in my just-released Special Report, 9 Good Reasons to Remain Bullish. You're invited to download it free.

Bull market opportunities like this don't last forever so it's important to make the most of them.

That's why I loaded up the report with 4 stock recommendations that have exceptional upsides. I suggest you consider buying promptly before too many others jump in. Your opportunity to get the big picture and the trades to take advantage of it ends midnight Sunday, May 22.

Free Download: 9 Good Reasons to Remain Bullish

Happy investing!

John Blank

John J. Blank, Ph.D. is Chief Equity Strategist at Zacks Investment Research. His daily commentary and top recommendations are available through your 30-day trial of the program that gives access to all our portfolios, Zacks Ultimate.

 




Normally $25 each - click below to receive one report FREE:



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