The theme I’ve been concentrating on-the Dow Jones industrial average’s climb toward a new all-time high at the same time large numbers of stocks are weakening-is playing out in dramatic fashion.
The Dow is only 150 points away from a new high, and it may well reach it. What’s working is obvious now (energy, metals, industrials), and I say, ‘Stay with them until they break down.’ But there is a growing portion of the market that is giving people fits, and I want to tear into that today.
One group of stocks pulled off amazing heroics after the bear market ended in late 2002. These went almost straight up for three years, but fortunes seemed to change in August 2005.
The home builders defined the bull market until recently. As they started falling from their August peak, I heard a lot of people talking about selling them short. The time wasn’t right for that because the group rallied, and almost returned to their highs by the end of the year.
They failed to break out of their August highs, however, and they have been struggling since. This is a textbook example of when the best risk/reward ratio presents itself for shorting.
If you short on the way up, it is difficult to tell how far investors will take an idea before it tops. If you short after a few down days, investors are typically still enamored with the group and keep buying the dips.
The best time to short is after the stocks have suffered a little, and investors are getting tired of holding stocks that continue to lag the market. Stocks like this seem to drop of their own weight, and home builders finally fit this bill.
Big-cap technology stocks like Microsoft, Dell and Intel are still some of the most widely held issues in the market. Today, these stocks are the equivalent to an investor of a land mine. Everything seems to be moving right along and then-bam! Intel drops 20 percent in a week. Ebay gives up 30 percent in days. Dell is getting shot as I write this.
A lot of investors are getting hurt in large tech stocks now. And because none of these stocks are anywhere near their all-time highs of early 2000, there are still plenty of upset investors who will be looking for an exit. I believe all of these stocks can be shorted on rallies.
I know the growing ranks of baby boomers keep a lot of attention on health care, and the trend may well help those stocks long term. But for some reason, the near-term picture for pharmaceutical and biotechnology stocks looks bleak. Biotechs, on the other hand, are taking on the glide path of a brick.
One of the most obvious areas of weakness is beginning to spread to other sectors. Rising interest rates are effectively ending the 25-year bull market in bonds. Utility stocks are one immediate victim. Perhaps the home builders are falling into this same web. With the recent breakout of the 10-year note above the 2004 high, things in bond land could get ugly fast.
I want to throw out a word of caution regarding the stocks that are working now. Basic materials and industrials look very extended, which leaves them vulnerable to even a little selling pressure. Any new money may be best served sitting in cash until some of these hotter areas retreat a little.
Hauke is the CEO of Samex Capital Advisors, a locally based money manager. Views expressed here are the writer’s. Hauke can be reached at 566-2162 or at email@example.com.