How do fish get caught? They trust the bait and open their mouth. How do investors get burned? They trust the market and buy into it. Obviously, for most of the time owning stocks is as important for a portfolio’s growth as eating for a fish’s survival.
However, there is a time to be cautious. When the waters are infested with fisherman and bait, it’s better for the fish to go hungry for a while. Even though not every potential meal is bait, keeping its mouth shut will ensure not getting caught.
Courtesy of the recent rally, investors who didn’t bail on stocks earlier this year enjoyed a feast of profits. After predicting a bottom below Dow 6,700 earlier in 2009, the ETF Profit Strategy Newsletter foretold this massive rally from the March lows via the March 2nd Trend Change Alert. At the time, Dow 9,000 – 10,000 was given as a target.
With the Dow eclipsing its target for a market top, odds that today’s bargain may turn into tomorrow’s money pit have increased exponentially.
ETFs tied to high octane sectors such as financials, real estate, technology and materials are likely to fall harder and faster than the overall market once reality catches up with this overvalued market. ETFs warranting a short leash include the Financial Select Sector SPDRs (XLF), iShares Dow Jones US Real Estate (IYR), the Nasdaq QQQ (QQQQ) and other technology related ETFs, and the Materials Select Sector SPRDs (XLB).
Small-cap stocks such as the iShares Russell 2000 (IWM) are likely to get hit harder too when the liquidity crunch resumes. Even though broad market index ETFs like the S&P 500 SPDRs (SPY), Dow Jones Diamonds (DIA) and Vanguard Total Market ETF (VTI) will hold up better than the aforementioned, they won’t provide a safe hiding place.
Of course, savvy investors wouldn’t touch double or triple leveraged ETFs such as the Ultra Financial ProShares (SDS), Ultra Financial ProShares (UYG) or Ultra Real Estate ProShares (URE) with a ten-foot pole in current conditions.
Even though it may sound irrational to cut loose some of this year’s top performance at this time, it makes sense to lock in profits while you’re ahead. Those who’d like to squeeze the remaining potential for profits out of the market may decide to equip their ETF holdings with trailing sell stops. This would protect against a major decline and leave the door open to reap what may be left on the upside.
Based on the facts discussed in another article (Three Disturbing Facts for the Bulls), this potential should be quite limited and is more than neutralized by a huge downside risk.