Many investors are deeply suspicious of the 60% run-up in stocks this year and are itching to sell. But then what? Here's how to take some gains now while setting up a profitable 2010.
Feeling twitchy?
Your portfolio is probably full of stocks trading at 52-week highs, and a correction seems overdue. I'll bet you've thought about selling.
How to read a company balance sheet
What to do? Let me lay out a three-part strategy for you and suggest a few stocks with strong fundamentals and good upside potential in 2010.1. Build a cash management plan -- and put it to use There's a huge difference between sitting out a nasty correction with all the money you had budgeted for college tuition, an annual tax payment or the down payment on a house safely in cash and having to liquidate investments at fire-sale prices and scrambling for cash. The last thing you want to do in a downturn is to take a big hit on your portfolio and then wind up losing a real-estate deal or having to yank a kid out of college.
If you're nervous about the next six to 12 months, cash out the money you anticipate you'll need over that period at prices that are today 60% above where they were in March. If you have to keep $60,000 in cash so that you can sleep at night knowing that you've got your financial bases covered, then the loss of a potential gain on that money is worth it. I've sold into this rally to sock away my kids' tuition for 2010 and my tax payment for next year. The cash is earning close to nothing, but the peace of mind, I've found, more than makes up for the lower return. More from MSN Money and MoneyShow.comHas Apple blown its big chance?The dark side of emerging marketsHere comes the big tax squeezeJubak on video: The great global tax dilemmaAnother revolution on the way in ChinaJubak on video: Strong auto sales are encouraging2. Accept that momentum is real -- and can be your friend Over and over during this rally, I've heard from investors who have said, "The stock market is ahead of the fundamentals of the economy," or, "This rally is built on nothing but the world's central banks flooding the financial markets with liquidity."
I totally agree. This is a liquidity-driven rally. It's based on the huge influx of cash from government stimulus programs in countries such as the United States and China. But that doesn't mean that any dollar you make in this rally is worth any less than a dollar made on virtuous fundamentals. And the idea that somehow by participating in this rally investors are destroying the republic, motherhood and the legacy of Warren Buffett and Benjamin Graham is, to my way of thinking, misguided. You take what the market gives you, and if it's a strong rally built on momentum, you say, "Thank you."
And the market's momentum is, at the moment, very strong. It looks like stocks have just successfully tested their October lows and have moved above their October highs. Since I wrote a blog post titled "You may not like the fundamentals, but this rally is headed higher" on Nov. 16, the major indexes have moved to within striking distance of a 50% recovery of all the ground that they lost in the collapse from the October 2007 highs. A move above what's called a 50% retracement would signal to technical analysts and momentum investors that this rally has further to run.
Video: Market correction isn't coming -- yet
Technical analysis works because it summarizes in charts and figures the psychology of large numbers of investors. There is still a huge amount of cash on the sidelines, even after this rally. Much of that belongs to institutional investors who desperately don't want to fall any further behind the performance of the market indexes. So they'll put money into the rally because they feel they must. It's that feeling that the technical indicators are capturing right now.
And what will those investors buy?
They'll buy the stocks, especially the big stocks, that have been going up. They don't have time to wait for value stocks to show their value. They want performance now -- before the end of the year.
To take advantage of this momentum and this psychology, you, too, should buy the stocks that have been going up:
The danger, if you're a fundamental investor, is that you'll fall in love with these stocks and be unwilling to sell them in cold blood at the first sign that their technical indicators are turning down. Fundamental investors tend (and I tend, to be honest) to justify holding on to a momentum buy even as the momentum fades because they believe in the company's fundamental story. In a market trading on momentum, great fundamentals won't save a stock when the momentum turns.
So how do you avoid this trap, one that's especially dangerous after a 60% gain?
Continued: Lean, mean earnings machines
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I’m almost as surprised that I’m agreeing with SaltGuy as I am that he’s agreeing with Jim. But, they are both right about keeping your near term cash needs safe and liquid. The type of market we are in right now is all about the power players preying on and devouring small investors who stumble or unwillingly fall into a short-term trap. Unfortunately, this means a short term defensive strategy must be part of your long term offense, even though it will most likely cost you some earnings.
I’m playing the same game right now for a different reason. I’m planning to build a house over the next 12 months (yep, I’m the one guy in the universe), and I want to self finance the project (no mortgages, no bridge loans, no fees, no banks - yea!). I actually started on this path two years ago, only to find that even the bond investments I had allocated to fund the project had dropped in value enough to threaten the whole strategy. Hear that Wall Street? Whether it’s individual home construction or a utility company pollution control project, VOLATILITY KILLS large scale projects. Fortunately, the value of my bond investments recovered last summer and I was able to move them into money market funds. No interest now, but, it’s definitely there. Get the backhoe ready, it’s time to break ground.
I agree - nice article. And, I also agree that Jubak doesn't often come up with gems. I too, am retired and living off of a portfolio. I was lucky that I had 47% of my net worth in cash entering the crash. Problem is: now that the CDs matured, cash yields are trash. I will sustain a 60% reduction in my income for 2010 now as a result. OUCH. Sooo.... I must invest at this market top and buy safe dividend payers. Finding anything not overvalued is almost impossible, but there are SOME candidates (I have been buying) out there.
We will get higher inflation and a devalued dollar way before we get higher interest rates to "rescue" the retirees. There are a few things that I see that will kill this whole thing off: 1] Skyrocketing health insurance premiums (if you think the "reform" is going to help here, you're dead wrong - remember the 35% excise tax planned on "Cadillac" policies in addition to a 30%/year premium increase) , 2] Hyperinflation because of the printing presses cranking out $$$ at a breakneck pace, 3] Another market crash when they DO raise interest rates (probably no more than 75 basis points) sometime in late 2011 or early 2012. Yes, we'll probably have a fed funds rate of 0.25% at least until sometime in 2011. This all makes it tough to plan ahead.
I think this country is ready for a Marxist Socialist totalitarian government now because it will manage to destroy the currency and economy, and bankrupt the vast majority of citizens in the process. They will have no place to turn but a "nanny" government. We are well on our way to achieving this result. "Change, we need!!"
Remember November, 2010, and your voter's ID card if you don't like the direction we're headed. A third of the US Senate and ALL of the US House of Representatives come up for re-election. You do have a right to vote - at least for now. This might be a good time to exercise it before it is taken away.
I wish all of you luck -- you're going to need it!!!!!
An excellent commonsense column. There are some ETFs that manage bonds & notes which do better than leaving cash in a brokerage money market or in a savings account.
As some of my stocks have run up (one went from about $5 to about $20!!! Lucky guess), I've sold half & turned to a bond fund & left the other half to ride whatever comes.
I just moved my entire IRA from index stocks to a guaranteed 5% return plan that is FDIC backed... I am no expert, but I think we will have a big down-swing sooner than later... I expect a big drop right before Christmas and another in late January taking the DOW back down to 9,000...
The problem is that inflation will kick-in very soon (with all of this printed money), and that 5% will only "feel" like 2%... Not good but not as bad as losing it.
I hate making decisions on fear, but I have no confidence in this administration. If everyone is in line to receive free turkeys, who is going to be left to hand them out? See you at the poles in November 2010! The problem is that they can do a LOT of damage between now and November without any checks & balances.
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