Last week, the investment team met for several hours and one of the main topics of conversation was the extended condition of several sectors of the stock market. We have seen this before during the past thirteen months. The S&P 500 Index will get more than 10% above its long-term 200 day moving average and then correct about 8% over a period of several weeks, and then go on to make new highs. The most volatile (highest beta) cyclical sectors will correct closer to 20% during these brief episodes, and then reward patient investors by once again leading the market higher. There is no doubt that financials, consumer discretionary, industrials, and materials have been the market leaders in this raging bull market environment.
At our meeting, we specifically considered either trimming or selling outright the consumer discretionary sector, which has confounded analysts concerned about high unemployment and weak residential real estate prices, by having some of the strongest earnings gains of all S&P sectors. On one hand, it seems to make sense to sell the leaders after a strong run to buy a lagging sector, the idea being that the leaders will mean-revert to more average returns and the laggards will catch up. On the other hand, it is a well known rule in the investment world that one of the biggest mistakes that you can make is not to let your winners run. Lots of money has been left on the table by investors who took their profits too early. Confusing the situation even further is our basic outlook which calls for the market to continue to work its way higher during the year, although we are aware that we are entering the worst seasonal part of the year to invest (“Sell in May and go away).”
For me, the most important question is whether or not we should couple taking some profits from a winning security with the notion that we can defend against a market correction that is due to appear any day now. We are 1 for 2 during this bull market in timing these short-term dips in market value. Our conservative and moderate portfolios would only decline 3% to 5% if the S&P 500 retreats to its 200-day moving average. I’m not sure that is significant enough to worry about. As of today we decided not to take our winners out and shoot them, but we are continuing to look at this trade. Perhaps the Greek fiasco will be the catalyst for the next correction and we will shortly be discussing buying the dip, instead of shooting the winners.
