6 reasons to take your profit now
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Reasons abound to suggest the market's about to pull back. So, I'll take some profits and wait for new opportunities in the fourth quarter.
By Jim Jubak
“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 ($COMPX) 37% gain from the March 10 low to the July 14 high on the table. That same investor would have missed out on almost half of the Dow Jones Industrial Average’s ($INDU) 20% rally.
But it’s starting to look like go 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.Compare rates.
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And although it’s too early to tell for sure, it is 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 that I’d call “Play for the Fourth Quarter.”
A play for the fourth quarter
Let me lay out the risk/reward calculations that make that an attractive strategy right now. This 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:
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 Standard and Poor’s 500 stock index ($INX). 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 indexes finished in the black.
This rally is looking tired. 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 indexes, 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- 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 Standard & Poor’s 500 has repeatedly failed to break resistance at 1,015 and the Nasdaq Composite has dropped below 1,700. The indexes are still within the recent channel but they look like they’re headed for the bottom of that channel at 972 and 1,696, respectively, and they’re close enough to those levels that it’s tough to rule out a drop below what has been a solid floor during the rally.
We’re starting to see selling on good news. Stocks that beat Wall Street 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, news, msgs), the parent of this site, 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 that 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 like this, 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 market didn’t rally on good news from Intel (INTC, news, msgs) either.
The price of the 10-year Treasury bond has been falling, pushing yields higher. The bond market has pretty much retraced all the gains that 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 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 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 since 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 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 effect buy and sell decisions.
No investment strategy is without risks and there’s certainly a good chance that 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 1,696, 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 have lagged the Nasdaq, has out performed 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 ($TNX.X, news, msgs) 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, 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 for this market.
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With the sell of AOL Time Warner (AOL, news, msgs) that you’ll find at the end of this column, 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 Pepsico (PEP, news, msgs) and Berkshire Hathaway (BRK.B, news, msgs) 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.
Changes to Jubak's Picks
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Sell AOL Time Warner, AOL
Shares of AOL Time Warner have continued to rally as the date for the company to announce second-quarter earnings, July 23, approaches. The stock is now within shouting distance of my $18 target price, and I’m going to use the current momentum to sell my position in these shares. The stock is up 30% in the last three months but down 77% since I added shares to Jubak’s Journal in November 1999. The stock is still a reasonable play on a recovery in the economy and a pickup in advertising revenue. But the likely strengths of the Time Warner half of the company in that environment have to be weighed against the likely continued weakness in the AOL business as the company gropes for a way to reignite growth in its online service. There are better ways to play a potential ad recovery. (Full disclosure: I will be selling my personal shares of AOL Time Warner three days after this column is posted.)
New developments on past columns
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In this rally, don’t spit into the wind
All good things have to come to an end. On July 1 State Street Corp. (STT, news, msgs), one of the most dependable growth stocks in the financial sector in the 1990s, announced its first quarterly loss, 7 cents a share, since the second quarter of 1977. For the period, the company took a $292 million charge for restructuring.
But the all-important process of holding onto the client assets that State Street acquired when it bought the custodial business of Deutsche Bank stayed on track. Assets under custody rose to $8.5 trillion in the quarter, which included $1.9 trillion from the acquisition. Analysts had worried that State Street would lose a substantial portion of the $2 trillion in client assets it acquired in the deal. Taking out the acquisition, State Street showed organic growth in assets under custody of about 10% to $6.6 trillion from $6.2 trillion. Revenue grew to $1.08 billion from $1 billion in the first quarter of 2003. As of July 22, I’m raising my target price on State Street to $49 a share, from $48, by December 2003.
Editor's Note: A new Jubak’s Journal is posted every Tuesday, Wednesday and Friday. The Wednesday edition stems from Jim's appearance on CNBC’s Business Center most Wednesday nights at approximately 5:45 p.m. ET.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: AOL Time Warner, Berkshire Hathaway, Microsoft, and Pepsico. He does not own short positions in any stock mentioned in this column. |
