Editor's Note: This article was originally published on May 6. It was republished to the TSC archives May 22.
The Great Bull market of 2000-2002 just might be history. Now, before you email me and request what's in my cigar case, there really has been a bull market.
Perhaps not in the new nifty fifty, not in the mega-caps and definitely not in technology stocks. However, many nontechnology small- and mid-cap stocks have been rallying nicely for the better part of the past two years. Financial, retail, industrial, consumer durable, restaurant, health care and raw material sectors have been generating excellent absolute returns for a while. This "stealth bull market" is evident in the performance of many small- and mid-cap indices.
Because of attractive valuations, I have owned and recommended many stocks in this part of the equity market. My portfolio -- and the portfolios of many value-oriented managers -- has been participating in this bull market.
But now I think it's time to sell into this rally and reduce equity positions in general. In order to reduce my equity position to about 50%, I am scaling back winning positions, including stocks mentioned in prior columns such as
Black & Decker
. I have bolstered my short positions in technology and large-cap stocks. I have not locked my entire portfolio down in preparation for a catastrophe, but I do feel that prudence dictates some profit-taking.
Why am I taking profits in these stocks? Valuation is the most important reason. Many stocks have rallied to fair value, even if one adjusts profits higher for a continuing economic recovery. Also, I am concerned about the quality of the recovery. The inventory kicker to the economy is about over, and most consumers and companies have not yet truly reliquefied their balance sheets. Should the economy fade again, investors will be much less forgiving of earnings disappointments.
As a proxy for the average stock valuation, I use the Value Line median price-to-earnings ratio. Currently, that number is about 21, essentially an all-time high. Some of this represents depressed profits, but the valuation is expensive even if profits recover. Also, we are entering the poor season for stock performance. I tend to give seasonal patterns the benefit of the doubt.
Finally, most investors remain fully invested and complacent. Sure, they are hurting and concerned. Bur very few have capitulated and materially reduced, in an active manner, their commitment to equities. When the vast majority of my family, friends and associates stop looking for stock tips, the market will have bottomed.
Many readers' emails have requested more recent long ideas. Quite simply, there are none. My buy discipline is to purchase stocks after significant declines to compelling valuations with respectable fundamentals. Today, nothing fits. The average stock is up, quite a bit in many instances. I do not shop the new-high list. Other areas, especially mega-caps and technology shares, are down. However, few of these are trading for compelling valuations.
Some stocks are down significantly and are cheap on "normalized" earnings. I have taken a few small positions in special situations and turnarounds, but for the most part I am not a turnaround investor. These ideas may or may not work, but I save my formal recommendations in this column for fat pitches.
For the past few months, my advice has been fairly consistent: avoid most large-cap stocks, sell or short technology and look for opportunity in the small-/mid-cap sectors. I reiterate the first two parts of that advice today. Most large-cap stocks trade for 20 to 30 times profits with poor earnings and declining growth rates. (At some point I intend to write an entire column on the issue of legitimate growth rates.)
Even the value part of the large-cap market is expensive, as the term "large-cap value" has become an oxymoron. Irrespective of categorization, value or growth and cyclical or defensive, the large-cap sector is expensive. Avoid the mo-mo stocks here as well as the no-mos.
For most technology stocks, it is not too late to sell. Valuations are still high, and fundamentals will be poor for quite some time in many parts of the technology economy. My guess is that at the bottom, investors will loathe tech shares more than they loved them at the top!
Current price-sales and normalized price-earnings ratios are more reflective of bull market optimism than bear market despair. Did valuations matter in the throes of that last
rally? You bet they did, despite the foolish advice of many to the contrary. As I wrote, "valuations matter, they always do." Good luck if you purchased a tech stock in the past four months. You are getting a serious and expensive lesson about disregarding valuation.
Because I heed my own advice, the part of my recommendations about finding value in the small-/mid-cap part of the market needs to change. The bull market in this sector has eliminated the compelling valuations. There still exists relative value, but the opportunities for big absolute returns in cheap shares have vanished. My own investment experience has taught me that when I can't find anything to buy, selling is the best strategy. Spend some of those bull market profits on a nice vacation and wait for a bottom this summer or fall.
Robert Marcin is the principal of Marcin Asset Management, a private investment firm. Formerly, Marcin was a partner at Miller, Anderson & Sherrerd and a managing director at Morgan Stanley, where he managed the MAS Value fund (currently Morgan Stanley Institutional Value). At the time of publication, Marcin held positions in Black & Decker, Liz Claiborne, Tommy Hilfiger and Tricon Global, although positions may change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Marcin appreciates your feedback and invites you to send it to