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The following is a post by MPFJ staff writer, Kevin Mercadante, who is professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He has backgrounds in both accounting and the mortgage industry.
The Dow Jones Industrial Average is back to setting record highs. Good news? Sure!
But it also means that we are now in uncharted territory. There are no charts to look back at and say “this is how the market behaved the last time the Dow was this high…” This is a whole new dimension that requires a different way of looking at the market.
Just as with any other level of the Dow, or any other index, the market can either continue to rise, to float sideways for very long time, or to decline, even substantially. But what makes a record high unique – and a bigger question – is that the directions can carry greater weight.
The market can continue to ride the same euphoria that blasted the Dow past the 14,000 level, all the way up to 20,000 and even beyond. It can enter a period of confusion, not knowing where to go, because of the conflict between optimism and the unknown. Or you can get a sudden fear of heights, where millions of investors decide to lock in the profits and cash out, dropping the market several thousand points.
Where will it go? Who knows – but it’s best to have a strategy for any one of three scenarios.
If you anticipate that the market will continue moving higher
If you believe that the market will continue to go higher, the best strategy will be to continue doing what you’ve done so far, with only minimal modifications to be prepared for changing circumstances.
For example, if your portfolio has at least kept up with the general market, you may want to keep most of your money in the stocks and funds where already is. The same factors that have carried them this far will probably keep them growing.
But as market leadership tends to change as markets advance, this is also an excellent time to begin looking at other sectors and companies. While certain sectors may lead the market to new highs, leadership may shift over to sectors and companies that have not performed quite as well. This is because investors and investment managers will be looking for new opportunities as the market advances.
If you believe it will be range-bound
If you believe that the market will go sideways for a prolonged period time, perhaps as it consolidates for the next move up or down, you may also begin looking for a change in leadership among sectors and companies. In a range bound market, some sectors can fall as others begin rise. The stocks that brought market up to the top may not be the ones that will lead the way in the next surge.
Again you will want to look at sectors and companies that have strong fundamentals, but did not perform quite as well on the run up.
This may also be the time when you look to take profits. You may want to sell off some of your better performing assets, and move them into somewhat more conservative investments.
This is not a time to begin exiting the market, but you might want to consider investments that will provide you with a steady income, while enabling you to participate in the next move up. Growth and income type stocks and funds can be the perfect choice. You’ll earn income from dividends – which will also provide at least some price protection – and if the market does resume its rise, you’ll be in a position to take advantage of that.
This can also be an excellent time to look for value stocks, and funds that invest in them. There are stocks in companies that are fundamentally sound, but they didn’t do as well as the Nifty Fifty stocks that drove the market to a new record. Prices of these stocks can be relatively low compared to the better performing competitors. They will also represent of the best opportunities in a range bound market. As the market looks for new leadership, value stocks are a natural choice.
If you think the market will fall for a long time
If you think that the market has run its course, and may be ripe for a multi-year decline, then this is the time to put diversification into high gear.
You never want to leave the stock market completely, but this will be the time to begin reducing your positions. Because the market is in record territory, it will be the best time to sell and take profits. Even if the market rises another 2,000 or 3,000 points, you’ll still have made rich profits.
You can build positions in sectors and companies that are likely to do well in the current economic environment – value stocks and funds would be a perfect choice. Even in declining markets, capital is always going somewhere, and it’s usually when markets decline that investment managers start looking for bargains.
You’ll also want to begin moving money out of the market. This will not only be a matter of protecting your profits, but it will also free up cash so that you will be able to buy bargains later on after the market has fallen.
Any type of interest-bearing investments would be suitable for this purpose. It could be treasury bills, certificates of deposit or money market funds – any place where your principal will be protected, and you can earn some income while you were waiting out the market transition.
How about you all? Where do you think the market is headed now, and what do you think is the best way to react to the various possibilities?
Share your experiences by commenting below!
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