Caution Key in Second-Quarter ETF Forecast

Tickers in this article: EEM IAU IEF TLT VWO

NEW YORK (TheStreet) -- Throughout the market's early year run up, investors who have ventured into risk have seen the strongest returns.

Major U.S. stock indices are pushing to historical highs while emerging market ETFs like the Vanguard Emerging Market ETF and the iShares MSCI Emerging Market Index Fund have managed to lock in returns of more than 10% returns.

On the other side of the coin, interest in the defensive asset classes that proved so attractive during the troubled second half of 2011 has fallen by the wayside. During the middle of March, the bottom dropped out for U.S. government-issued debt securities and funds including iShares Barclays 20+ Year Treasury Bond Fund and the iShares Barclays 7-10 Year Treasury Bond Fund slipped to new 2012 lows.

Gold also seems to have lost its footing. The iShares Gold Trust showed some inklings of strength during the opening months of the year. However, with the Federal Reserve's continued hesitance towards the topic of quantitative easing, the bullion-backed fund has struggled to head higher. The floundering has led some market commentators to question whether this precious metal's multi-year bull run has exhausted itself.

As investors prepare to close the book on Q1 2012 and look to the second quarter of the year, the market's prospects appear promising. Much of the domestic economic data continues to point to improvement and with the busiest part of earnings season slated to get underway during the opening weeks of April U.S. companies should stay in the headlines.

Meanwhile, although I still encourage investors to look elsewhere for international exposure, Europe appears to making solid progress as it works to resolve its ongoing sovereign debt crisis. History is even on the side of the bulls; April has traditionally been one of the best months of the year for equity returns.

Many signs point to improvement, but the rally's continuation is far from a sure thing. On the contrary, as we learned last week, there are substantial hurdles that still stand in the way. Slowdown fears in China, for instance, threaten to reignite growth doubts that could quickly derail the market's strength. At the same time, although employment figures and consumer-related reports point to strength, we continue to see signs that indicate the U.S. housing sector remains weak.

Blind bullishness is dangerous and, therefore, aggressive and conservative investors should have these factors in mind when prepping their portfolios for the road head. Dividend-paying equity ETFs like the iShares Dow Jones Select Dividend Index Fund or the Vanguard Dividend ETF offer jittery investors a chance to maintain stock exposure while protecting against a potential correction.

Meanwhile, investors can boost their level of safety by paring back exposure to excessively risky emerging markets. Single nation products like the iShares MSCI Thailand Investable Market Index Fund or the Market Vectors Brazil Small Cap Index ETF may be enticing during periods of relentless upward action. However, if clouds gather, instruments like EEM and VWO may be better choices. Their globally diversified investing strategies can help mitigate downward action.

The road ahead may not be perfectly smooth, but ultimately I do not feel that we should be heading for the exits here. By refocusing attention towards slightly less risky instruments, it is possible for even the most fearful investors to ride out a potential squall.

Written by Don Dion in Williamstown, Mass.

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Tickers in this article: EEM IAU IEF TLT VWO