Is Now the Time to Sell (at Least Some) Stocks?

So much of the chatter on cable television and radio shows and online is about when to buy and when to sell stocks (and bonds, gold and other investments). Nearly all of the pundits engaging in such calls have terrible track records and many grossly misrepresent their past success.

My regular readers know that I'm largely skeptical of market timing. I find much of it amusing and to be a terrific source of excellent fodder for new articles, especially for the Guru Watch section of this site. The best, long-term investment managers I know don't try to time the markets. They identify securities selling at attractive valuations and make their money that way. 

Now, don't get me wrong. I'm not advocating blindly throwing money into various funds or investments without first taking stock of your personal situation and some macro factors in the financial markets. I favor a value-oriented tilt and certainly avoiding bloated sectors of the market (such as technology stocks clearly were in the late 1990s).

What worries many folks right now is the near-term memory of the ugly stock market slide that we experienced. From the peak to the trough, global stocks dropped more than 50 percent in value in less about two years for the most severe stock market slide in decades.

When financial markets make such a sharp move down, some investors understandably get skittish, panic and sell what's been dropping the most (e.g. stocks). I witnessed numerous folks doing just that during the sharpest part of the market slide in late 2008. Unfortunately for many such sellers, they failed to get back into stocks before the massive rebound.

If anything, because of the stock market sell-off, investors should have boosted their stock allocations back to previous levels. I explain the logic and details of this in my article on rebalancing.

Now is certainly a fine time to reconsider your overall allocation given the powerful global stock market rally the past 18 months. In the absence of any tweaking, your stock allocation has surely crept higher as stocks have been the best performing asset class over this period.

Are Stocks Overvalued?

Now, let's turn our attention to another question so frequently discussed among the pundits in the media and online: Are stocks overvalued and set to fall? Answering such a question is far, far more difficult than most people realize because:

• Your global stock portfolio has components from dozens of markets around the world. (This, of course, presumes that you've taken my advice to be properly diversified in stocks worldwide.) Many of the discussions by pundits about supposed market valuation fail to clearly define what stocks they think are overvalued or they may be implicitly or explicitly limiting their comments to U.S. stocks. Are stocks overvalued in the U.S.? Japan? Germany? South Korea? You get the idea...valuation discussions rarely get that specific and therefore are near worthless from the get go for the globally diversified stock investor.
• There are numerous ways to value stocks so it's not as if there's a simple formula that anyone can use that allows them to know for sure if stocks in general are priced properly. I've certainly discussed some measures on this site and in my books. Valuing stocks is complex, not simple. This is one reason why I advocate using professional money managers with demonstrated track records of success.
• Even if you can definitively determine that stocks are overvalued, that doesn't mean that they are certain to fall. Suppose that right now that they are actually overvalued. One way to correct that is for stocks to fall. However, stocks could continue to rise and/or their fundamentals could catch up to them. Granted, if you're looking for a good exit point to lighten up on your stock holdings, knowing that stocks are fully valued could be useful information.

Some Simple Considerations

Back when stocks had been doing well for a number of consecutive years (e.g. 2003-2007), that would have been a good time to evaluate your stock holdings if you were concerned about being over-weighted in stocks. During and just after the severe 2008 global stock market decline, by contrast, was a poor time to consider selling. Stocks fluctuate and why on earth would you want to sell when there's widespread pessimism?

If you otherwise need or want to reduce your stock holdings, doing so now, after the powerful rally of the past 18 months, certainly could make sense. That said, there's hardly widespread euphoria right now. In the U.S. and in some other important developed countries, there's still plenty of nervousness and pessimism about the low strength of the economic rebound and relatively high unemployment rate. There's also concern about government deficits, government spending and monetary stimulus possibly triggering inflation.

For sure, there's always something to worry about. That said, there's still quite a bit of concern and negativity in the air. That's why polls are showing that many incumbents are in trouble for next Tuesday's mid-term elections.

Compared with the stock market lows in late 2008/early 2009, now is certainly a much, much smarter time to lighten up on stocks if you've wanted to do so. But, it's hardly as ideal a time as what existed, for example, in 2007.   

Using the 250-Day Moving Average as a Guide

Here's a relatively simple measure you can use to assess whether a given market index may be offering you a better or worse exit point. The 250-day moving average shows you what the average level has been for a given index (or security such as a stock) over the prior 250 trading days. 250 trading days amounts to about one year's worth of trading days. (Many market analysts use the more traditional 200-day moving average but that never made sense to me since it covers an odd length period of time - about 9½ months.)

Take a look at the chart below for the Dow Jones Industrial Average, the widely followed U.S. market index. This chart covers the past 10 years. You will see that back in late 2001 (following the September 11 attacks) and then in 2002 and early 2003, the Dow index fell dramatically below the 250-day moving average (250-DMA). This is indicative of times when prices are really depressed and thus a poor time to sell (but a time to consider buying).

 

During the subsequent market rebound, the 250-DMA caught up with the index and followed along with it during a substantial portion of 2004-2006. Not until 2007 did the Dow index rise significantly above the 250-DMA thus indicating a possible better time to sell for those wanting to lighten their stock holdings.

During the severe market drop in 2008 and into early 2009, you can see how the Dow index fell way below the 250-DMA indicating that it wasn't a good time to sell (but an attractive time to buy). Currently the Dow index is modestly above the 250-DMA. So, as I said earlier, not a bad time to sell some stock holdings for those wishing to do so but we're probably not yet seeing the kind of attractive exit point that existed back in 2007.