We Answer The Key Questions

3/28/2011


Q The market is up big over the last two years. Indexes have been choppy in recent weeks. Should I sell?

A With the S&P 500 Index up 96% from its March 2009 low, the temptation to take some money off the table is understandable. As always, your asset allocation should reflect your individual return requirements and risk tolerances. So, if the market's rebound means you now have enough money to satisfy you, consider locking down your retirement needs and selling some stocks.

For the rest of us, we think it's too early to sell. The three primary drivers of stock prices — corporate earnings, inflation, and interest rates — remain favorable. The typical U.S. stock is trading at a small premium to 15-year norms based on measures like price/earnings ratio and price/cash flow ratio, and large blue chips are trading at a discount to historical norms. More important, we're still finding quality stocks that fit our growth-at-a-good-price approach, especially in the technology sector but also among financials, energy, and consumer names.

All that said, things can change quickly, and we are watching the market averages for evidence of a deteriorating investment outlook. From a Dow Theory perspective, the ability of the Dow Industrials and Dow Transports to surpass their mid-February highs is crucial. With closes above 12,391.25 in the Industrials and 5,298.10 in the Transports, the bullish primary trend would be reconfirmed. A failed attempt to reach new highs in both averages would be discouraging, especially with a subsequent breakdown below the respective March lows of 11,613.30 and 4,950.00.

For now, our plan is to watch the averages while holding 9% to 15% of equity portfolios in a short-term bond fund as a partial hedge. A move to confirmed new highs would not trigger an immediate boost to our stock-market exposure, but it would provide reason to add more stocks as opportunities develop. As always, our twice-weekly hotlines will provide updates on significant Dow Theory developments and any changes to our recommended portfolios.

Q The situation in Japan looks pretty bad. Will it get worse? And if it does get worse, should I change my investment strategy?

A Many of the areas hardest hit by the earthquake and tsunami still lack power, water, and other basic services. But both private and government operations have already begun to resume in other parts of the country. The disaster wreaked havoc on Japan's east coast, with the government estimating that more than 18,000 people died.

Also of concern are problems at the Fukushima Dai-Ichi nuclear power plant. Large quantities of radiation have already been released, and seawater near the crippled plant now shows high levels of radioactivity. The worst-case scenario of a Chernobyl-style meltdown now seems unlikely, but Japanese authorities warn that extraordinary cooling measures may need to continue for years.

Barring another cataclysmic event, Japan will soon begin a massive rebuilding process. Japanese consumers and businesses have absorbed a body blow and will not recover overnight. But business activity is slowly reviving in Japan, and we do not expect the disaster to derail the global economic expansion.

Many U.S. companies will suffer near-term problems with their supply chains. Those with significant sales in Japan face a near-term hit to revenue. But some U.S. companies stand to benefit from rebuilding efforts and reduced capacity among Japanese rivals, and the overall hit to U.S. corporate earnings for 2011 is unlikely to be substantial. We would not advise changing your strategy based on the disaster in Japan.

Q I've been out of the market for a while and am holding a lot of cash on the sidelines. Should I invest it?

A If you'd be comfortable holding stocks you owned already, you should be comfortable buying them. The only major differences between holding and buying are commissions and taxes, so don't delay getting into the market because you are waiting for the perfect buying opportunity. If you're worried about getting in right before a correction, you can hedge your risk by feeding your cash into the market gradually over three to six months.

One key to long-term success in the stock market is staying in the market. Consistently calling market zigs and zags with precision is nearly impossible, and timing the market in an all-or-nothing fashion is among the best ways to wreck your long-term returns. The stock market ebbs and flows, and successful investors tend to ride out those movements, adjusting market exposure based on circumstances but never abandoning stocks altogether. Also, by constantly looking for opportunities in the stock market, even when times are bleak, you'll have a better grasp of whether stocks are generally cheap or expensive.


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