Six Reasons to Take Your Profit
By Jim Jubak
MSN Money Markets Editor
07/23/2003 07:03 AM EDT
"Go away in May."
That's the old Wall Street chestnut, but this year it would have cost you plenty. An investor who left the market May 1 would have left 19 percentage points of the Nasdaq Composite's 37% gain (from the March 10 low to the July 14 high) on the table. That same investor would have missed out on almost half of the Dow Jones Industrial Average's 20% rally.
But it's starting to look like going away in July and August might not be such a bad idea. The risks are greater than they were when this rally began, and there's enough potential uncertainty on the horizon to keep the stock market on edge. To add one bit of history to your unease, the second half of July historically ushers in the worst three months of stock market performance, on average, in the year.
And although it's too early to tell for sure, it's beginning to look like professional investors are moving to the sidelines. That could well keep the market treading water for a while. Why not? If your portfolio is up 20% this year, why not play it safe and move to cash?
After a great second-quarter rally, these investors may be ready to adopt a strategy I'd call "play for the fourth quarter."
A Play for the Fourth Quarter
Let me lay out the risk/reward calculations making this an attractive strategy right now. It applies to market timers trying to catch the ebbs and flows of this volatile and uncertain market, or to long-term investors trying to figure out the best time to put cash to work.
The factors arguing in favor of playing for the fourth quarter include the following.
Moving to the sidelines now locks in a positive return for the year to date. And it's close to, if not greater than, what most investors hoped to achieve for all of 2003. Remember that the bullish hope at the beginning of the year was for a gain of 10% on the S&P 500. Well, the index is up about 12% as of July 18, the Dow is up 10% and the Nasdaq Composite is up 28%. Don't underestimate the psychological value of being ahead, either: You have to go back all the way to 1999 to find a year when any of these three indices finished in the black.
This rally is looking tired. It's nothing big to worry about yet, but technical indicators are showing signs that this market is finally getting ready to take a rest. July 17 marked the third straight day of losses on the three major indices, and the market has clearly reversed its rally pattern of opening weakly but finishing the day strongly. Instead of that sign of continued investor enthusiasm for stocks, the market recently has been opening strongly and then finishing weakly as investors sell into the upward trend in prices.
Some key leadership sectors have declined below the 20-day or 50-day moving averages that provided support in this rally: Drug, networking and health care stocks have all violated these support levels recently. The S&P 500 has repeatedly failed to break resistance at 1015, and the Nasdaq Composite has dropped below 1700.
We're starting to see selling on good news. Stocks that beat Wall Street's earnings expectations for the second quarter aren't getting much of a bounce -- not even if they also guide projections for future results upward. Microsoft (MSFT:Nasdaq - news - commentary - research - analysis) is a good example: The company announced second-quarter earnings that were a penny short of expectations on revenue that was well above Wall Street projections. And the company said revenue for fiscal 2004 would be as much as $1 billion above earlier projections and that earnings per share for fiscal 2004 would range from 85 cents to 87 cents (after expensing stock compensation), again above Wall Street expectations (of 83 cents.)
All that resulted in the stock getting a very modest 1% bounce at the start of trading on July 18. Selling later in the morning reduced even that gain. When investors react to good news in this way, it's usually a sign that they think the recent announcement is the last bit of good news they'll hear for a while.
The price of the 10-year Treasury bond has been falling, pushing yields higher. The bond market has pretty much retraced all the gains it racked up since the Federal Reserve jawboned interest rates lower with its May 6 warning of deflation. The decline in bond prices has rattled investors who wonder how long it might continue and has given investors worried about stock valuations something more to think about. Investors who have been arguing that stocks are reasonably valued because interest rates are so low, now face the unpleasant fact that rates have climbed back to the neighborhood of 4%.
Analysts like to lock in "profits," too. It's common for analysts to downgrade stocks after a strong rally and when the market seems to be turning weaker. It's also typical for analysts to fine-tune earnings projections for the next quarter as soon as they see results from the previous period. And because very few companies are saying that business will be better than expected for the third quarter, a lot of this fine-tuning is likely to take earnings estimates for the third quarter lower in the next few weeks.
According to Thomson First Call, Wall Street's estimated earnings growth for the stocks in the S&P 500 could get trimmed as low as 11% for the third quarter, down from the current 13% projection, and fourth-quarter estimates could get cut to 15% from the current 20%. That will put downward pressure on stock prices -- while also setting the bar lower for actual third-quarter numbers when they're reported in October.
The national mood has shifted toward pessimism. The end of the Iraq war and the latest tax cut helped boost the national mood and stocks with it. The mood today, as far as I can tell from reading the headlines and the poll numbers, has shifted toward pessimism. The peace in Iraq now seems as deadly as the war, and the focus has shifted from the stimulus of the tax cuts to the size of the deficit. There's not much concrete in this shift to change stock prices, but investor psychology does affect buy and sell decisions.
No investment strategy is without risks, and there's certainly a good chance the period ahead will turn out to be much better for stock prices than the six factors above would indicate. So what's the chance that by going away in August, you'll miss a significant opportunity for profit? I don't know that for certain, but here are a few points to ponder:
* The rally could very well continue, after a pause. Even after the recent down days, the upward trend in stock prices remains intact. As long as the S&P 500 holds above 972 and the Nasdaq Composite above 1696, the upward trend hasn't been violated.
* Sectors currently in favor may run out of steam, but that doesn't necessarily mean the market itself is tired. If new leadership sectors begin to emerge, expect investors to rotate into those new areas. In the last few days, for example, the Dow Jones Industrials, which lagged the Nasdaq, outperformed the technology-laden index.
* The economy might actually start to deliver concrete good news showing that the much-anticipated second-half recovery is actually on its way. That would be sufficient to erase current doubts and would send new money back into the stock market. The market would actually move ahead on this good news.
* The price of the 10-year Treasury note could stabilize at current levels or even start to climb -- sending yields lower -- as investors decide that 4% is an attractive return and as worries about the size of the deficit drop off the front page.
* Lastly, cash flows could overwhelm news flows. There's a lot of cash on the sidelines that's just looking for a chance to get back into the market at a reasonable price. That could well limit the downside of any pullback.
Cash Offers Safety and Flexibility
As you can probably guess from the amount of space I gave to the reasons for expecting a flat or down market in August -- and thus in favor of a "go away in August" scenario -- I find the glass half-empty right now. I'm not expecting a radical downdraft in stock prices that destroys the longer-term upward trend. I am, however, expecting a big enough retreat that it makes sense (for me, anyway) not to put money to work here, but to wait for better entry points and lower prices.
But despite this weighting to the downside, which reflects my best judgment on the short-term market, I think I've given you enough of the pros and cons for you to make up your own mind about the right strategy.
With the sell of AOL Time Warner (AOL:NYSE - news - commentary - research - analysis), I've moved Jubak's Picks from fully invested in March to about 50% cash.
I don't see the point of selling stocks like Pepsi (PEP:NYSE - news - commentary - research - analysis) and Berkshire Hathaway (BRK.A:NYSE - news - commentary - research - analysis) just for the sake of selling. They're not especially volatile in themselves, and will hold up well in a market retreat. And they're exactly the kind of "safe" stocks that could outperform if increased volatility spooks some investors.
My high cash position, however, will give me a measure of overall safety in what I expect to be a flat market -- but that could turn out to have unexpected downside volatility. And it gives me plenty of flexibility to play for the fourth quarter.
Fred |
