One pleasant thing about the stock market is that dominant trends do not change quickly. A strong, healthy bull market does not turn into a nasty, hungry bear overnight.
There is a process and an evolution that a full market cycle goes through, and the transition phases of these cycles typically last three to nine months. Investors who become aware that they are in the early to middle stage of one of these transition periods will have ample time to react and prepare to profit from the change.
After a particularly long and ugly bear market (long and ugly can mean percentage losses or length of time, or both), markets can bound higher in a spectacular fashion. After the initial euphoria wears off, the new bull market is powerful and broad, taking almost every sector and industry along for the ride.
As the bull market matures, investors in some sectors become a little more willing to part with their shares and the total breadth of the rally begins to narrow. Corrections get a little deeper and the volatility slowly increases. This middle stage can last for many months to a few years. At some point, though, sellers begin to overtake buyers in a majority of the sectors within the market. Whatever life is left in the bull market is typically concentrated in a small number of stocks. These stocks, however, enjoy massive gains in short time frames.
The last stage, obviously, is the market tops and the next bear market begins.
We are now entering the early stages of phase two. The strategy here is to be slightly more willing to take profits on stocks that have not done well in the recent past. Since the highs in the major indexes have not been seen yet in stage two, investors have to be diligent about reinvesting cash reserves during market corrections. The areas to concentrate on for reinvestment are the sectors that did the best during the correction (barring defensive issues). Constantly pruning the portfolio increases the probability of success in this phase.
Stage two is not the time to panic either when the indexes hit new highs or when corrections take place. This stage can last for a long time and lead to great profits.
January is usually the best month of the year for mutual fund inflows. But the first week of February saw the best inflows in three months. Maybe mutual fund investors were waiting for the election in Iraq to pass. There are a lot of positive developments on the geopolitical front right now. The Israeli and Palestinian meeting in Egypt has the potential to usher in a period of peace in the Middle East. The stock market has been forecasting good times for the foreseeable future.
The Dow Jones utility index was the bestperforming major index in America last year. Despite the 2005 theme of last year’s winners are this year’s dogs, the utes are once again the best-performing index in the country. It’s funny that not one expert has been saying anything positive about utilities even after their great run. That alone means there probably is more meat on that bone.
Hauke is a local money manager. His column appears weekly. Views expressed here are the writer’s. Hauke can be reached at 566-2162 or at keenan@samexcapital.com.
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