As the FTSE 100 wobbles around 4,500, many investors are tempted to sell up. Whilst taking profits makes some sense, it's not the time to be selling everything.
I am dumbfounded.
This stock market rally has gone far beyond my wildest dreams. Sure, when the FTSE 100 was down below 3,500 in early March, you could easily assume a bounce was overdue. But this is more than a bounce. In just under three months, the FTSE 100 has rocketed 30% higher from its March lows.
As of now, the FTSE 100 sits just above the psychologically irrelevant level of 4,500. Yet it appears most investors still think this is nothing but a bear market rally. Some even think the markets will retest their March 2009 lows.
For example, Nick Louth, a private investor I very much respect, recently said in the Financial Times "I fully expect a retest of March's lows before the end of September."
Louth had the guts to pile into the market during March. It was a time of extreme fear, and very few of us were willing to take the plunge, especially as the market was in freefall. He bought some recovery companies, like Taylor Wimpey (LSE: TW), Cookson (LSE: CKSN), Xstrata (LSE: XTA) and Land Securities (LSE: LAND).
The Brown Twigs Of Economic Despair
Louth is now taking profits. He admits some of the recovery companies he invested in are lower quality. Low-quality companies are rarely suitable for a buy and hold strategy, especially during these dodgy economic times. As Louth himself says, "It is prudent to take profits…in case economic 'green shoots' turn out to be brown twigs."
I love the term 'brown twigs'. All the talk for the past few weeks has been about the green shoots of recovery. In reality, there have been very few green shoots. Instead, we've had economic data that has been less bad than it has been previously. Instead of whole branches falling from trees, we've had yellow leaves floating down to the ground. But they've still been falling.
Or Giant Oak Trees?
There is nothing like a strongly rising stock market to make you feel good. There is nothing like a strongly rising market to give you the impression that everything is going to be alright again. There is nothing like a strongly rising market to give you the impression that the green shoots of recovery are here, they are real, they are here to stay, and they are going to eventually turn into giant oak trees.
Right now, who knows what the economy will look like this time next year? Will we be fighting inflation? Will we be stuck in a deflationary spin? Or will everything be going along just swimmingly, with a little bit of growth here, a little bit of employment there, here a slight interest rate rise, there a strongly rising pound, everywhere sunshine, e-i-e-i-o?
And what does all this mean for the stock market?
It's Time To Take Some Profits
My gut feel is similar to Nick Louth's -- it's probably a decent time to take some profits, particularly on some of the lower quality and/or cyclical companies in your portfolio. I've already done a bit of selling. I'm going to do a bit more. But I'm not going to sell everything, because…
1) I may be wrong. This stock market rally may continue. Looking at the market another way, rather than saying it is up 30%, you could say it is still down 33% from its 2007 highs. Back in 2007, if someone said in 2009 you'd be able to buy shares in 2009 at 33% off, you'd have jumped at the opportunity.
2) I've largely avoided, or at least I like to think I have avoided, buying 'trash stocks'. I have some legacy trash, which has mostly already been thrown out.
3) I am not a market timer or a market trader. I'm happy to leave that to the day-traders and their speadbetting accounts. Selling everything today would be a call on the short-term direction of the market. If I was making that call, I'd have probably sold everything a few weeks ago, completely missing this latest leg-up in the market.
4) Unlike Louth, I don't think the market will retest its March 2009 lows. I do think we've got more economic pain to come, but I just can't see the absolute fear and panic we witnessed in March being repeated to that extent.
5) There are still plenty of high quality, high yielding companies available at cheap prices. GlaxoSmithKline (LSE: GSK) for example, trades on a price to earnings ratio (P/E) of just 9 and a dividend yield of 6%. Why would I want to sell them?
The market and the economy remain tricky to call. Taking profits remains a sensible strategy, as does buying and holding quality companies trading at cheap prices. As ever, opportunities abound.
If you are interested in specific share ideas, our Motley Fool Champion Shares stock picking service is always on the hunt for cheap stocks -- the cheap stocks Chief Analyst Maynard Paton thinks offer the most enticing combination of safety and upside potential. You can get instant access to all his latest stock picks with a 30-day free trial. Click here for more details.
More on the economy and the markets:
> If you're in the market for buying shares, consider opening an online broker account with The Motley Fool's Share Dealing Service. You can buy and sell shares in real time for a flat rate of just £10. Click here to find out how you can open an account for free today. There is no obligation to trade.
> Of the companies mentioned in this article, Bruce Jackson has an interest in GlaxoSmithKline.