This guest post comes from Kevin at 20smoney.com, a blog covering financial topics such as investing, money management and the development of income streams.
Despite the fact that most people tend to think that a market that has already booked a 60%+ rally is a great time to be invested in stocks, I tend to lean the opposite direction. With such a massive run already in place, the risk/reward scenario is not nearly as good as it was when compared to earlier in the rally. So, how should you play the current environment?
The sectors with some of the largest gains this year have been technology and financials. As such, these sectors warrant extreme caution if you are currently long or are getting long any companies within these sectors. If you want to be long the sector, but aren’t sure of specific stocks, consider mutual funds or ETFs such as Financial Select Spider (XLF) and Technology Spider (XLK).
If you’re looking to gain exposure in these sectors, I strongly encourage you to monitor some basic technical signals so that you can identify a clear exit point in case the broad market and/or these sectors reverse and head lower. Watch the 20 and 50 day moving averages. If the stock (or ETF) breaks through these key averages, be ready to exit the position. If you don’t feel comfortable with such a strategy and want to take a more long term focus, I would then wait for a significant pullback, at least 5%, to enter your position. Remember, you’ve already missed a large run in stocks, and you need to be careful entering a position at these levels.
If you have held stocks this year, especially in the sectors named above, you may consider actually selling some of your positions to lock in profits. Taking profits is never a bad idea, and if you don’t want to pull out completely, simply sell half or maybe a third of your position.
If you are looking to enter other long term positions, I would point you towards dividend paying companies that will pay you to hold them. This will help offset any losses in share price if there is a reversal in the markets. Also consider multi-national companies that generate a significant portion of their earnings from abroad (this will help you hedge against weakness in the U.S. economy). In this category, consider Philip Morris International (PM), Wal-Mart (WMT), McDonalds (MCD) and perhaps Microsoft (MSFT).
For me personally, I’m pretty bearish on the economy and the markets. I’m skeptical on the strength and durability of the recovery and the stock market rally. I believe that we have structural issues with our economy that have not been addressed and therefore will prevent real growth. I’m not adding to any positions in the current environment, rather I’m “keeping my powder dry” waiting for much more attractive buying opportunities. I do own gold related instruments such as GLD and GDX because I think gold has the potential to perform well in both an inflationary recovery and a deflationary environment (pretty much the only asset with this ability).
As I mentioned above, if you’re looking to try and make a few bucks on the continued rally in the broad markets, be extra careful and be ready to exit by monitoring some key technical sell indicators. Protecting your money is a better strategy, in my opinion, than chasing returns, especially today. If you’re a long term believer in the recovery and the future of the economy, get long some solid companies, but don’t be afraid to be patient and wait for better entry points.