Business Week : Five Reasons to Sell, Sell, Sell !!

Business Week ^ | 07/20/2007 | Ben Steverman

[SirLinksalot]

U.S. stocks are at record levels. Earnings season is under way, with many expecting a modest rise in corporate profits. Unemployment is very low. So far problems with housing haven't infected the rest of the economy, which seems poised to bounce back from slow growth in the first quarter.

So what is there to worry about? Plenty. No matter how wonderful things look, the good times won't last forever. Even as most market observers remain bullish, we asked them what could derail this bull market. Stocks could keep setting records for months or even years, but it pays for investors to know what dangers are lurking out there. This Five for the Money lists the five biggest threats to the stock market rally.

1. Earnings

Will any stocks and sectors step up to the plate to push the market even higher? Investors are closely watching corporate earnings for clues.

Earnings season began this month and so far it's not clear whether corporate profits will keep pace with expectations. Expect a lot of volatility in the market as big players surprise investors with good or bad news. David Scott, chief investment officer of the Chase Large Cap Growth Fund, expects less support for the rally from financial and health-care stocks. So he's watching tech stocks closely. "They're a large enough part of the market that they can provide solid leadership," Scott says. Disappointments from big tech firms or key players in other sectors could scare the bulls in a big way.

2. Consumer spending

Consumers drive the U.S. economy, and so far they've held up well despite housing problems and high gas prices. Perhaps that's because unemployment is low -- at 4.5% in June.

What are the risks for consumer spending? Charles Dumas of Lombard Street Research believes the U.S. economy is growing much more slowly than many on Wall Street think. One reason is weakening consumer spending. "Gas prices are really knocking the stuffing out of people's buying power," he says.

Some think Americans, who save very little and borrow a lot, are about to be hit by the realization that they need to cut up the credit cards. "We've been addicted to spending and borrowing, and we need to stop that," says Peter Schiff, president of Euro Pacific Capital.

Watch closely for data later this summer on the back-to-school season, which is an important time for retailers. "If this back-to-school season is bad, it could really highlight some weakness in the consumer," says Neil Cataldi of Susquehanna Financial Group. High energy prices might also catch up to consumers later this year, if heating costs rise as the weather turns colder.

3. Inflation

"Inflation is still a concern out there," says Sam Stovall, chief investment strategist at Standard & Poor's. Several factors could push inflation higher, including rapid global growth, the tightness in the job market, or higher commodity prices. For example, S&P forecasts oil, now about $75 per barrel, could be headed above $80.

Why are rising prices such a big deal? "The Fed has said, 'We will stop at nothing to defeat inflation,'" says Richard Sparks of Schaeffer's Investment Research. The faster prices rise, the more likely that Federal Reserve policymakers could decide to hike interest rates later this year. That would cool off the economy. The biggest worry is that the Fed is forced to raise rates while the economy is still growing only slowly, forcing the economy into a recession.

4. Subprime and housing

O.K., here's the really scary one. Many on Wall Street believe the problem with subprime mortgages is limited and under control. They may be right, but it's impossible for anyone to predict how many debtors will ultimately default on their obligations. Many home buyers used creative financing to buy expensive houses in the years of booming home prices. "It's a tough one to get a handle on because we're not really sure what's truly at risk," Scott says. "It could spring on us suddenly."

What other forms of risky credit threaten debt markets beyond subprime? Bill Larkin, portfolio manager of fixed income at Cabot Money Management, believes he's already seeing signs that subprime worries are spreading, rocking other areas of the credit market. He sees a "flight to quality," with many bond investors fleeing not just subprime but anything with a hint of risk.

If the trend accelerates, it becomes even tougher for home buyers to get mortgages, pushing home prices lower. It also becomes more expensive for companies and hedge funds to borrow. That could cut off the flow of money into stock buybacks, mergers, and acquisitions, especially the private equity buyouts that have fueled the bull market. "Just like raising rates, this acts as an economic brake," Larkin says.

"People are starting to get nervous," Larkin adds, but it takes a while for these trends to show up. "It doesn't just -- boom -- happen." Are there lots of other forms of bad debt out there? Are lenders -- as Larkin jokes, "using their garage door as collateral?" No one knows. "That's where the risk is," he says. "There's not a lot of transparency here."

Pimco bond guru Bill Gross has warned investors not to think subprime is only a problem for a few hedge funds or investment banks. The problem affects millions of home buyers who financed their houses with cheap money but are now seeing mortgage payments rise along with defaults. Gross wrote in his July investment outlook, "This problem -- aided and abetted by Wall Street -- ultimately resides in America's heartland, with millions and millions of overpriced homes and asset-backed collateral with a different address -- Main Street."

5. Shiny happy investors

As markets rise, the bulls' success may be their biggest weakness. Too much optimism can derail a rally as quickly as too much gloom and doom.

It's a cliche on Wall Street that markets like to climb a "wall of worry." The more doubts about a rally, the more headwinds it faces on the way up, the more likely a bull market has a firm foundation. "We like to see some pessimism in the market," Schaeffer's Sparks says. Concerns about interest rates, terrorism, gas prices, or inflation? "Those are the bricks in the wall of worry."

Despite the index's record-breaking pace recently, experts like Sparks still see signs of skepticism. To gauge this, investors can look at the amount of short-selling -- trades betting stock prices will fall -- or ratios between puts and calls.

Sparks also keeps an eye on the media, including articles like this. Be on the lookout for articles proclaiming "happy days are here again," Sparks says. If the media is sounding too positive about stocks, it may be a sign that retail investors are jumping into the market. And if the average investor is buying again, you can bet the "smart money" is selling, and stock prices are near peak levels.

For another look at whether the bear is on the bull market's heels, see BusinessWeek's slide show.

[The South Texan]

6) Contributions from Wall Street are going more to Democrats than Republicans. If they are hedging their bets on Hillary!, then we are in trouble.

Sounds like it might be a good time soon to sell.

[SirLinksalot]

Commercial real estate. Overpriced.

Which ones ? National, International or both ?

[enough_idiocy]

“Even the dullest voters will figure out by 2012 that you can’t blame the Republicans for everything when ‘rats control both the white house and congress”

Really? Look at any liberal city, say Baltimore for example, Detriot or New Orleans. Run by dems for literally decades, no improvements, nothing good happening and yet voters continue pulling the same lever and buy the blame whitey/GOP talk. I have no faith in the electorate.

[rfp1234]

Domestic REITs, which have higher P/E than the S&P 500.

[steve8714]

The economy is sound...the market is strong...that doesn’t mean we won’t see a correction, though, nor that any such correction would be small (2% or less) or brief (2 months or less). Timers who get lucky may prosper, those who aren’t may weep.
“Bulls make money, bears make money, pigs get slaughtered.”
-Cramer

[rb22982]

Isn’t the S&Ps P/E ratio lower than the rolling 50 year average right now? I can’t see why the stock market wouldn’t continue to advance unless we hit a huge bear market.

[EQAndyBuzz]

“So which shares have you shorted and why?”

Pharmaceuticals

[upcountryhorseman]

Agreed: they seem to be moving up.

[ItisaReligionofPeace]

The sky is falling, the sky is falling!

[labard1]

Actually, the MSM has a remarkable record for ALWAYS being wrong at the critical turning points. Business Week’s bearishness probably means there’s more to go on the upside (regardless of the underlying merits of stocks and the economy).

[cynwoody]

Timers who get lucky may prosper, those who aren’t may weep.

Recently, Schwab put out an article on market timing strategy. They back-tested five strategies for investing $2000 a year in the S&P for the 20 years ending in 2006:

• Invest the $2K at the market low for the year.
• Invest the $2K as soon as you receive it.
• Invest one 12th of the $2K every month.
• Invest the $2K at the market high for the year.
• Leave it in cash at Treasury bill rates.

Here are the results:

They also tested 62 rolling 20-year periods, going back as far as 1926. In 52 of the 62 periods, the five strategies sorted in the same order as above. In no case did invest immediately come in last, although it came in fourth during the 1962-1981 period.

[quant5]

Steep recession in 2009 is what I have predicted. I see it this way also as one economist in the article suggested -growth based on Wall Street is happening more slowly then what it thinks. This statement in and of itself is false. Growth on Wall St. is based on numbers and numbers alone. Corporations in sectors such has housing just had windfall profits and still appear somewhat healthy, energy is at all time profit, steel and other building commodities still at great profits. Global outsourcing and corporate profits have been amazing.

What he is feeling as other economists mentioned is the status of our economy and the middle class. I have been conservative, never had lots of extra toys, always drove cars 2-3 years old, saved some cash. Guess what? The cost of living where I live has risen 42% in five years based on spread sheets I manage. I am a CEO of a business I own. My salary of $80k needs to be $125k. I put aside almost every pleasurable activity that costs pennies. Now I am putting some necessary bills on credit cards and will tap into my home equity for the first time.

Yes, I will find a way to make the $125k and am working 15 hours a day to do it and still working smarter. My wife is also going back to work. My middle class friends families now both work full time, six days a week (4.5% employment stat) and/or long hours and are defaulting on credit cards, mortgages because they already tapped their home equity. The middle class woes are beginning to be felt on Wall St. as nervous twitches. If anything, I will invest in real estate a year from now and buy up a duplex or two and rent them out.

[quant5]

Why?

[xc1427]

Absolutely!!!

[EQAndyBuzz]

I don’t believe the pharmaceutical industry could withstand the political pressure and the lawsuits that the left is going to bring down on it. Look what Clinton did to the companies making vaccines.

[Vermont Lt]

I will admit to selling half of my Apple Stock today. I bought it at $36 and figured that no one ever went broke taking a profit.

Of course now, I am trying to figure out where to put it.

Oh well...what do you know about JDSU //sarcasm off

[quant5]

They may pass legislation that effects one part of their marketing effort and hence sales: physician marketing. I don’t think they will do it. The dems are too focused on bringing Bush down and besides, the dems need all the money they can get and won’t piss on big pharma until at least after the election is over.