How to run with the bull market and avoid the bear
A bull market will roar through the winter, followed by a bear market, says a Canadian analyst who advises investors how to deal with both.
Enjoy the bull market while it lasts. There’s a bear waiting in the woods.
While it may often seem like “irrational exuberance,” says one analyst, you can expect things to be bullish for the next few months.
This opinion comes from the normally cautious Mr. Keith Richards, a seasoned portfolio manager.
“Irrational exuberance” was the phrase used by Mr. Alan Greenspan to describe the stock market boom of the mid-1990s. Mr. Richards tends to think of the 10-month market rally we’ve been having in the same terms.
And yet the charts also afford some reason for short-term optimism, he writes in Investor's Digest of Canada.
Indications are that the Dow Jones Industrial Average (which stands at about 10,660 today) should reach 11,500 sometime in the winter months.
After that, watch out.
The writer explains why he thinks we have room for more exuberance and how we should handle it. He recommends two exchange-traded funds and one Canadian financial stock that is doing better than its peers.
After that, he will “present you with some thoughts as to why and when we should consider taking profits and reducing stock market exposure.”
Head and shoulders
Back in 2007, says Mr. Richards, the Dow Jones Industrial Average broke through the 11,500 barrier and shot up to almost 14,000. We know now, of course, that this was simply “the illusion of the emergence of a new bull market.”
But now there are two reasons to think that the Dow will return to 11,500 at least. The first is technical.
The Dow has recently formed what is known as a “head-and-shoulders” pattern. The average rises and falls three times, rising highest the second time (and thus forming the “head” between two “shoulders”).
This pattern has an impressive track record for predicting upside market movement, Mr. Richards assures us. Calculating from this base, he gets a figure above 11,000.
The second reason is more easily comprehensible to the technically challenged. It is the simple fact that the markets historically do best from November to May, and best of all in November, December and January.
Add the calendar evidence to the head-and-shoulders pattern, and you get “a bit more upside for the markets before spring arrives.”
Exchange-traded funds
In order to ride this upside profitably, you should look at the sectors that do best in the winter months, says Mr. Richards.
There are three: financial stocks, consumer stocks and small cap stocks. By consumer stocks, he means what analysts call “consumer discretionary” — things people want but don’t necessarily need.
Once again, this analyst consults his technical charts. And they look very bullish on the consumer discretionary and small cap indexes. But he does not recommend running out and buying a handful of individual stocks.
He prefers investing in these stocks through exchange-traded funds. He likes SPDR Consumer Discretionary Select Sector ETF (NYSE-XLF), which, he informs us, he owns personally and in the accounts he manages for clients. Today it’s trading at $30.
For U.S. small caps, there is iShares Russell 2000 Index Fund (NYSE-IWM). It trades at $63.46. Unfortunately, Mr. Richards tells us, he is aware of no equivalent ETFs in Canada for these sectors.
One exception
As for financial stocks, that means Canada’s big banks, right? No, says Mr. Richards. They appear to be reaching a ceiling, he says, “so we must be a bit cautious with that group.”
What’s more, he reports, Canadian insurers “have been reporting lousy earnings of late.”
With one exception. It is Great-West Lifeco (TSX-GWO). Its third quarter earnings did not quite meet consensus estimates, but they were positive. That made it the only insurance company to make a profit in the quarter. Rivals Manulife and SunLife both reported losses.
This superior performance and a 4.6 per cent yield on its $1.23 dividend make it a favourite of this analyst’s. Its technical profile also looks good, he says. Once again, he informs readers in Investor's Digest of Canada that he has held this stock personally and in his managed accounts for several years now.
At $26.61, it is trading fairly close to its 52-week high.
Want their money back
The fun must end, Mr. Richards assures us. He borrows from the rock group Trooper who sang, “We’re here for a good time/not a long time.”
There are three reasons why the good times should be over by the time we reach the second half of 2010, the analyst states.
First, if and when the Dow hits the 11,500, there is bound to be a sell-off by those who bought in at that level during the last bull run. “They want their money back, and will happily sell their stocks after waiting so long for their portfolios break even,” says the analyst.
Second, the markets can only go so far without further earnings growth, which in turn must come from revenue growth. A recent Bank of Canada report is skeptical about this, and so is this analyst.
Then there is something called the decennial cycle. This has been tracked all the way back to 1880. For unknown reasons, the analyst says, years ending in “0” tend to end badly on the markets.
“By itself, relying on this pattern may seem fairly superstitious or illogical,” Mr. Richards admits. But combine it with the possibility that both the Dow and corporate earnings will hit a ceiling and maybe 2010 will be added to the list of negative years ending in “0”.
“Stranger things have happened,” he concludes. In short, invest wisely for the next few months and don’t walk under any ladders.
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