A few weeks ago, I wrote a column about my increasing caution toward equities. The spring rally, which I had written about in March, significantly reduced the potential returns from stocks. I maintained that future rallies should be sold, as shares appeared much more fairly priced than they were at their October or March lows. Well, now I'm following my own advice and selling stocks. I'm not positioned for a crushing short-term collapse. My selling is more the result of adherence to my investment discipline, which espouses purchasing cheap stocks after significant declines and selling them into strength at reasonable valuations. Prudence dictates some profit-taking, especially because I believe we're still in a secular bear market.
Off the Table
What did I sell? Many of the "tech specs" that I purchased last autumn have been revalued to much fairer levels. Through last Friday, most of the small-caps from my speculation column have appreciated by triple digits. Although more upside exists in some of these ideas, others appear fully priced. Names such as Openwave ( OPWV), SeeBeyond ( SBYN) and Quantum ( DSS) have been eliminated from my portfolio. Others such as Epix ( EPIX), Artesyn ( ATSN) and Verisign ( VRSN) have been trimmed. Some, like Abiomed ( ABMD) and MRV Communications ( MRVC), I continue to hold. But, excluding Gundle ( GSE), few of them are cheap. Gundle is an exception because its price-to-earnings ratio is still low at 9, and the company is entertaining takeover offers. I also have made some changes to the "controversial" large-cap value ideas in my portfolio. Essentially, I have downgraded all of them, some to holds and some to sells. I have taken profits in Baxter ( BAX) and EDS ( EDS). I'm still holding others, including Tyco ( TYC), Cendant ( CD) and Cigna ( CI), because of their modest valuations.
What's Behind the Moves
The reasons for my lower equity exposure relate to valuations, sentiment and business fundamentals. At current price levels, the stock market trades for price-to-earnings and price-to-sales levels that appear fair to expensive on an absolute basis. Since the big rally, investors have become much more aggressive and bullish. Sentiment surveys and action in speculative stocks support this assertion. Finally, business fundamentals, especially corporate operating rates and unemployment claims/levels, are deteriorating. Current stock prices are discounting that ever-elusive second-half profit explosion. Things may get better, but I don't think they'll improve enough to support the big move in stock prices.