Just a year ago, as conversations inevitably turned to the plunging stock market, I felt like the odd man out. Most people doing the talking were boasting that they’d bailed out, cut their losses, moved into cash, hunkered down. And then I’d say I was buying. Most people looked at me like I was crazy. The deeper the market fell and the longer the correction persisted, the more isolated I felt. So I stopped talking about it, just nodding enigmatically when the subject arose.
Now, with the market continuing to set new highs for the year, most recently on Monday, I’m again feeling isolated. That’s because I’ve been following the Common Sense system, which calls for selling after large gains like the one we’ve just experienced. So while everyone else is celebrating their gains, I’m thinking about what to sell. Don’t get me wrong. I’m as delighted as everyone else by the market’s rise, since I’m always net long the market. But I’m not buying when the market hits new highs. Instead, I’m locking in some gains, raising cash for the day when a correction ultimately arrives.
Over the years I’ve been doing this, I’ve come to understand why this doesn’t make me all that popular with certain kinds of investors. Many people equate a decision to sell with a prediction the market is going down. Who am I to dampen the festive atmosphere of a big rally? But I don’t try to predict short- or even medium-term moves in the market. All I’m trying to do is sell higher, buy lower, and thereby outperform a strict buy-and-hold approach. So far it has been working. Earlier this year I was exhorting people to buy (see my Feb. 24 column, “Why right now is a good time to buy,” which includes a detailed description of the Common Sense system, and my March 10 column, “3 Stocks on my shopping list”), as I did myself. As luck would have it, I bought on March 9, which turned out to be the bottom.
My next selling target is 2220 on the Nasdaq Composite , and the index has come close on several occasions, most recently on Monday, when it hit 2205 midafternoon. This was close enough for my purposes, so I took advantage of the rally to sell my few remaining banking positions. As I discuss in SmartMoney magazine’s December issue, I remain concerned about continued deterioration in the commercial real estate market and its impact on bank earnings and balance sheets. This is a theme Federal Reserve Chairman Ben Bernanke addressed in his speech to the Economic Club of New York on Monday, when he noted that “Demand for commercial property has dropped as the economy has weakened, leading to significant declines in property values, increased vacancy rates and falling rents. These poor fundamentals have caused a sharp deterioration in the credit quality of CRE [commercial real estate] loans on banks’ books and of the loans that back commercial mortgage-backed securities (CMBS). Pressures may be particularly acute at smaller regional and community banks that entered the crisis with high concentrations of CRE loans.”
These problems are so well known that they should already be reflected in stock prices. But the efficient market theory was dealt a blow last year, when the well-known woes of residential real estate turned out not to have been reflected in bank stock prices. I expect something similar to happen again when there’s a big default in the commercial sector.
Also weighing on bank stocks have been various proposals in Congress to rein in supposedly abusive consumer banking policies, such as overdraft penalties on debit cards. Some kind of consumer protection legislation seems likely to pass, which may wreak havoc on bank earnings, at least in the short term. Bank stocks have been notably absent from the past month’s rally, especially the regional banks. But most have rallied strongly from their lows of the year, making them good candidates to divest now, in my view.
At some point bank stocks will again be a buy. But as this rally enters the equivalent of old age, and seems increasingly momentum driven, I’m avoiding the financial sector entirely.
Speaking of momentum, the luxury sector I recommended last week has been on a tear. Last Wednesday night Sotheby’s auctioned an Andy Warhol silk screen of 200 one-dollar bills for nearly $44 million, almost four times its high estimate. (That’s roughly $220,000 per bill.) Sotheby’s stock was at $17.50 last week; Monday it closed at $20.07. Luxury goods maker Compagnie Financiere Richemont reported on Friday earnings that beat expectations and sales rising in Asia. Its shares were up nearly 5% on Monday. These shares have now gotten too rich for my taste, but the trend should continue, making them good candidates to buy in a correction.
And while I don’t predict short-term moves, that’s one prediction I’m confident about: Someday a correction will come.