By Joseph Lisanti
Stocks have done well for the last few months. The S&P 500 gained some 25% from its March 2003 low through the end of July. And though we believe stocks will finish the year fairly strong, there is likely to be some choppiness in the market for a while. We advise removing a modest 5% from equity positions.
Historically, the third quarter is the weakest for stock performance. The month of September has been particularly bad. Since 1928, there have been fewer stock market gains in September than in any other month.
Mark Arbeter, S&P's chief technical analyst, notes that the "500" has been in a tight trading range recently. Though that range can persist, in most cases such narrow movement usually gives way to a breakout one way or the other. Arbeter believes that the next move will be down because few players have booked their profits from the recent advance, investors remain overly bullish and the market appears to have lost some of its momentum.
Our last allocation change was a recommended reduction in bonds from 15% to 10% of investment portfolios. That came immediately after the Federal Reserve lowered its target for the federal funds rate to 1%. On June 25, the date of the Fed's action, the 10-year Treasury note yielded 3.3%. Then bonds plunged in price. At the end of July, the 10-year T-note yielded 4.4%.
The higher bond yields provide increased competition for investors' cash. They also imply a lower fair value for stocks, based on the "Fed model," which compares the yield of the 10-year Treasury to the earnings yield (estimated earnings divided by price) of the index. The higher the Treasury yield rises, the less room stocks have to advance.
We advise switching 5% from stocks into bonds because fixed-income prices could rise a bit after their huge decline. We still see a likely buying opportunity in stocks later this year.
Lisanti is editor of Standard & Poor's weekly investing newsletter, The Outlook