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.
And you would do that -- except the stock market keeps going up, cash pays close to nothing, and it's hard to find a stock to buy that's not already trading at its 52-week high.
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.
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2. 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?
Try exchange-traded funds, or ETFs. Sure, you may be susceptible to the lure of Deere's (DE, news, msgs) fundamentals, but bury Deere inside the Market Vectors Agribusiness ETF (MOO) and the company is just one of a basket of stocks. It's easier to be coldblooded.
Continued: Lean, mean earnings machines
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, 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.
