The Big Rally
The call to "Sell in May and go away" is bouncing around the web. This expression is new to me, though it isn't wacky: Stocks do gain more from November to April than between May and October. This is part happenstance: The 1987 crash struck in October, 9/11 hit in September and the Dow Jones industrial average sank to its most recent bottom at 7200 in October 2002. But stocks don't follow a timetable except on the days surrounding a particular company's earnings announcement.
So, as we click off two months since the start of the rally that's added 10% to the total value of U.S. stocks, pay attention to the news, not the calendar. The mass of professional traders and investors approve of the financial headlines more than most consumers should. Where some of us feel the effects of slow economic growth, $3-a-gallon gasoline and homes sitting unsold, financial pros like the flat interest rates, low inflation, surging company cash flow and earnings, and global economic growth. All those are positive -- even ideal -- for U.S. and foreign stocks.
The length of the rally is also noteworthy. You can always expect a downturn like the one we saw in late February to be followed by a gain, but instead of being a brief "relief rally" (or the more ineffectual "dead-cat bounce"), this has been a serious surge. "The advisers and I were somewhat surprised at the strength of the rebound because the market indexes burst through to new highs instead of drifting lower," says Brandon Thomas, a Chicago investment adviser who selects money managers for individual investment advisers' and their clients. Thomas says planners and individual investors had the willies in February, but are over it. That's what I also hear from mutual fund managers, brokers and market strategists. Most of them are bullish. So are Kiplinger's columnist Jeremy Siegel and the panel of investment advisers in Russell Investment Group's latest survey.
Wall Street has been wrong before in failing to see the end of a bull market. But we're far more likely than not to see the Dow above 14,000 and Standard & Poor's 500-stock index above 1600 by year's end. That would produce total returns of about 10% for 2007, maybe a tad more with dividends. That's our expectation and we're sticking to it. But after any powerful charge, you have to brace for some backtracking. So the question is, what do you do about it?
Your to-do list
Start by seeing where your investments lie. If your stocks, bonds and funds are in IRAs, 401(k)s or 403(b)s, you can move around without owing taxes and sometimes without commissions. In other words, you can rebalance painlessly. If your plan was to wait to shake anything up until June 30 -- and remember, the calendar is arbitrary -- why not do it now?
The drill is to envision all of your investments and those of your spouse as one omnibus portfolio for evaluation purposes. For most long-term retirement investors, you'll want 70% or 75% in general stocks and stock funds (both U.S. and international), 5% in real estate investments, 15% in bonds and 10% in cash, or something similar.
You may discover after these big gains, 85% of your pot is in stocks. If so, trim to the original weighting, taking profits and putting the money in cash or a low-risk bond investment.
Next, within stocks, see where you are weighted. Lately, stocks of large, growing companies have led the way, and many of these stocks are in the Dow and carry big weight in the S&P 500. It's been frustrating to see stocks such as GE, Coca-Cola, 3M, IBM, Microsoft doing nothing for years while stocks of obscure small companies double and triple. But this tide has turned, says star Legg Mason fund manager Bill Miller and others in his line of work. Companies like IBM and Coke are more successful outside the U.S. than inside it. Profits earned overseas are worth more in dollars now due to the exchange rate. Small-company stocks have to be winded after seven years of run-ups. If you have too many bucks in small-stock funds or one-industry investments such as media or energy, trim them first and switch some to large growth stocks or funds.
Within your stock portfolio, it's right to maintain at least a 20% stake in international funds, both European and Asian. The idea that the rest of the world's economies and markets are the cart behind the American horse isn't as clear as it once was. Even countries like Brazil and Mexico have big dealings with China and Europe. Also, for real estate, consider a global or international realty fund rather than one with only American REITs.
Relax and enjoy it
Anything else? Yes. Don't get all wobbly if there's another day like February 27, when the Dow lost more than 400 points. The probable cause of the next one-day disaster would be the falling out of a private-equity buyout or other gigantic Wall Street. There's no question that merger fever, which greets the market daily before the traders start moving money, has helped to push the Dow and the S&P 500 to new highs. A company in one industry sells out for a princely price, and others in the same sector rally. Or fund managers try to bet on what company will be sold next. As long as this activity continues -- and there is so much extra investment cash on the loose all over the world that it will -- stocks get an extra push.
Higher inflation would be another warning to trim your sails. That's because stock prices reflect today's value of future earnings and dividends, which are less valuable when eroded by high inflation. But the difference of a few tenths of a percentage point on the consumer price index doesn't matter in the short run. You would have to feel enough extra inflation to signal the Federal Reserve Board and the bond market to push interest rates seriously higher and bring the nation to the point of a recession, not just recession talk.
Stocks in general are not overpriced. Steve Wood, a market strategist for Russell Investment Group, observes that the S&P 500 may be at a seven-year high, but just that means stocks haven't done much in seven years unless you traded in and out smartly. Yet corporate America -- in fact corporate Earth -- have been on a roll for several years. If anything, there's some catching up to do in the market, Wood says, though he agrees that in practice, you have to expect stocks to blow off occasionally. Most price-earnings ratios and, just as important, the ratio of cash flow to share prices, are appealing. This is not like 1999, when you saw P/E ratios of 40 and 50 on big blue chips that today trade for 16, 18 or 20 times 2007 profit forecasts.
The two-month rally has eliminated some raging bargains and means you'll need surprise good news on the inflation and earnings front to sustain a much greater advance. But that's not the same as warning that a bear market is gathering. That's hard to see.
So, when stocks take a beating for a week or two, tell yourself you've seen this before. Unless the cause is seriously troubling -- a financial catastrophe at a company more important than an Enron or a WorldCom -- you have the satisfaction of knowing that you'll be starting fresh in a few weeks from higher lows. That's how you make money in stocks over time -- wait it out. Enjoy.