Five Buys for a Fourth-Quarter Rally

I can give you five reasons to expect a fourth-quarter rally this year.

1. The market has rallied in mid-August to early October, during what is usually a weak period, to give stocks momentum in November and December.
2. Money is flowing out of real estate and bonds and into stocks.
3. Short interest climbed to multiyear highs on both the New York Stock Exchange and the Nasdaq in September, so there's plenty of pessimistic money to send prices higher when it turns optimistic.
4. We're starting to see rotation out of the stocks in the Dow Jones Industrial Average Index, which led the market upward in September, and into the more speculative Nasdaq stocks that typically lead a fourth-quarter advance. On Oct. 4, for example, the Dow Industrials climbed 1.05%, but the Nasdaq Composite rose 2.1%.
5. Thanks to an end of tax-selling in October, the stock market almost always goes up in November and December -- 16 out of the past 18 years, in fact.

You can increase your portfolio's exposure to a fourth-quarter rally by increasing the beta of the stocks in your portfolio.

Beta measures how well an individual stock is likely to match the ups and downs of the market as a whole. Stocks with a beta of 1 are as volatile as the market as a whole. Stocks with betas above 1 move faster than the market as a whole.

If the stock market as a whole is headed up, you'd certainly like to raise the beta of the stocks in your portfolio to capture that general advance of the market. No laggards wanted here.

But getting the big trends right and tuning your portfolio to the ups and downs of those big trends is only part of the investor's task and only part of what makes up a portfolio's return. The other part is called "alpha" in current financial theory. You and I probably call it stock-picking.

Alpha is the part of your return above what you'd get from just tracking the market or a specific index. Delivering alpha is what money managers get paid for. You can, after all, capture the market's return by buying an index fund such as the Vanguard 500 Index Fund and pay a minuscule 0.18% in fees.