Pennsylvania Investment Observer

A Change in Direction

by Daniel J. Nestlerode

After nearly two years of rising interest rates and much higher commodity prices, the stock market finally reacted, ending the bull market rally that began last October. On or about May eleventh, the stock market peaked at near record highs and started retreating with a vengeance. While some averages made record highs, other major indices never got back to their former highs from six years ago. You can argue whether we were in a bull market since 2003 or a bull market rally in a bear market that started in 2000. Both interpretations are correct, depending on the stock market average or index you use to illustrate your point. The more interesting issue is: where do we go from here?

With the rally behind us, we are now entering either a trading range market or a declining market. If this is a trading range market, the bottom side of the range has yet to be established. If the coming market is in fact a declining market for stock prices, the bottom could be in the neighborhood of the market bottoms from 2002 and 2003 (or even lower if you are a died-in-the-wool pessimist). In either event, as an investor in stocks, this is the time to lighten up on your holdings and move to cash, in my opinion. I say this because if we have a trading range market, this process is often highlighted with sudden severe declines in individual stocks as any kind of disappointing news hits Wall Street. The analogy often used is that we have hit a stretch of highway that is full of nasty pot holes. These are things to avoid. Cash doesn't often experience pot holes. If the market is headed decidedly lower, then you can sell now and buy back later at lower prices.

As readers of this column, your job is to review your portfolio and eliminate those stocks that are performing badly. By bad performance I mean that the stock prices are declining. Look for stocks that have fallen through their 50 day moving averages, their 200 day moving averages or have broken the trend line of higher prices established in 2003. These stocks should be sold and the proceeds held in cash, which, by the way, is again paying about 4%. Pay attention to your portfolio and as stocks break down in price, sell them and accumulate cash.

I suspect that by this fall, this decline will either be over or deepening even further. If the decline lasts through year end, you'll be happy you sold in June. If the market starts to recover in October and November, you can buy back in at that time at probably lower prices.

I could be wrong, of course, as no investment advisor can predict the future with certainty. Yet the Fed seems determined to raise interest rates at least one more time and world demand of commodities will likely keep their prices higher than usual. Of course, we could have a technical breakthrough in energy that would sharply reduce the costs of driving and cooling and heating your home. However, these events are difficult to anticipate and you should not be investing hoping to get lucky. You should be working now to benefit from the next upturn in stock prices.

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