On the technical front, more and more indicators are flashing warning signs. The markets look extended and investor sentiment points to extreme bullishness. Those are usually signals that we are due for a sell off.
That does not mean that the markets won’t go higher but the higher the averages climb without a pullback, the sharper the decline will be when it does occur. Remember too that pullbacks are good for the markets. Two steps forward and one step back is the rhythm of just about everything and the markets are simply a reflection of that fact of life. We have had a good run over the last few weeks and the averages are close to historic highs for good reasons.
The traditional Christmas rally was postponed last year because of concerns over the Fiscal Cliff. Prior to that, in November, some investors vented their disappointment over the re-election of President Obama by selling the market. They were convinced that without Mitt Romney the world would come to an end.
As a result, since the beginning of the year, many investors have been playing catch-up. As predicted, once the Cassandras had been proven wrong on tax hikes, spending cuts, the growth of the economy, the debt limit and whatever else they were fretting about, the bears have been making up for lost time and have been throwing money at stocks hand over fist.
As I explained last week, we may also be seeing the beginnings of a shift out of U.S. Treasury bonds and into stocks over the last few weeks.
All of this good news has kept the markets propped up. I expect that enthusiasm will continue over the very short term, but somewhere up ahead lies the possibility of a correction of up to 10%. That might sound like a lot (and it is), but those kinds of corrections normally occur once or twice every 12 months or so. We are overdue for this one.
“Should I sell now?” asks a client.
My answer depends on your circumstances. If you know that at some point over the next few months you will need to raise cash for college tuition, a new roof, an auto or other big ticket purchase, then it probably makes sense to take some profits now and make sure you have the money available for when you will need it.
On the other hand, if it is simply fear and greed spurring your desire to sell, I would advise against it. I have never met anyone who can consistently sell at the highs and buy back at the lows. The majority of times, those who try lose more money than they make.
“So I’m supposed to just sit here and take a 10% hit?” the client asks.
My answer is yes. The next thing long-time readers will point out is that over the past few years I have taken action on many similar declines. Why not now?
If I thought that something serious was lurking out there in the bushes, something that could drive the market down a lot further than 10%, then I might advise you to step to the sidelines. But I don’t see anything like that.
Europe is recovering, not failing. The Fed is easing and the government appears to be getting its act together. Globally, I see more growth ahead. No matter how much I beat the bushes, I just don’t see the kind of dangers that we have had to navigate over the last few years.
There is no way of telling when a correction will occur. We could easily gain another 4-5% before it occurs and there is no guarantee that if it does occur it will turn out to be 10%. It could be less, a lot less. In which case, selling now will be an exercise in futility. My advice for most investors is simply weather the decline if it occurs. I have a strong feeling that the markets will ultimately make back any losses they may incur and then some.