Without a doubt, a bull market is itself a bullish indicator.
There is a bit of a self-fulfilling prophecy here: investors clamor for gains and feel safer when the market flashes green than when it's awash in red. But even a more rational explanation to this phenomenon also makes sense: The stock market is a big discounting machine, reflecting bets that tomorrow's prices will be higher than today's.
But if this is a gauge at all, then, just as with any other market indicator, it's not an infallible one. No rally lasts forever, and after a boom -- as loud as it might be -- usually comes a bust.
On Tuesday, April 23, the S&P 500 closed at 2,931.11, higher than the previous all-time closing high of $2,930.75 set back on September 20. It only took seven months for the markets to return to previous highs -- one of the speediest turnarounds in market history.
And yet, many investors are not convinced that stocks are the place to be. According to the Conference Board, 37% of Americans believe stock prices will rise over the next year -- and 26% believe the prices will fall. The spread of 11 between optimists and pessimists is about half of what the spread was at the end of September.
The dizzying speed of the decline -- in only 14 weeks the markets dropped by nearly 20% -- evoked memories of past bear markets. These emotions, together with a 300% return already accumulated in this bull market, are the likely reasons many investors are not yet convinced that it's safe to return to stocks. It will take time (and the record-beating 17-week rally didn't give many investors enough time) to readjust these expectations. If the rally continues, though, they will.
Further, valuations might come into play. While the markets are not expensive by most measures, neither are they attractively valued. On the basis of expected (forward) earnings, the next 12-month P/E ratio for the S&P 500 is now 16.8; this is higher than both the 5-year average of 16.4 and the 10-year average of 14.7.
Let's Hunt For Overbought Stocks...
For investors who are concerned more about preserving gains or with the speed and sustainability of the recent rally, there is always the option of making small adjustments to their positions and raising cash. If you're concerned the rally will fizzle, or if you simply want to take some gains off the table -- the table below is for you.
In it, I highlighted some of the popular large-cap stocks that are trading at or near their 52-week or all-time highs. These are the stocks where taking some profits might be in order.
These large-cap stocks look overbought based on a combination of factors. Plus, they are not the fastest-growing group in the market. And for each company on the list, there are at least some signs of vulnerability -- these chinks in their armor mean that, if things were to deteriorate, they can be expected to weaken faster than the market. On the other hand, when valuations return to more normal levels, all else equal, this set of overbought/overpriced stocks will become more attractive as well.
As you can see, a few stocks in this table belong to the technology sector.
Up 25% year-to-date, Intel seems to be priced for perfection. It's an undisputed leader in semiconductors, and an income stock to boot. But with Advanced Micro Devices (Nasdaq: AMD) making advances in data-center technology, Intel's bread and butter, INTC's current expectations for only a slight revenue decline over the next year might prove too optimistic.
Another tech company on the list, Automatic Data Processing (Nasdaq: ADP) is, like Intel, priced to perfection. And, similar to Intel, there is more and more competition in its core business of human resources and human capital management solutions -- from more-traditional players like Paychex (Nasdaq: PAYX) to small-business focused TriNet (Nasdaq: TNET) to cloud-based Workday (Nasdaq: WDAY). Up nearly 26% year-to-date, consider taking some gains off the table.
Unlike the group above, Kimco Realty Corporation (NYSE: KIM) is a shopping mall real estate investment trust (REIT) trading far below its all-time highs. But it still looks expensive. While its open-air shopping malls are located mostly in the top metropolitan markets -- and mostly from grocery-anchored centers at that -- it's fighting a long-term e-commerce trend. Kimco may be an income stock, but this does not mean that it won't decline if its results disappoint or if the market deteriorates. I would be careful with KIM at this time.
Fastenal (Nasdaq: FAST), a wholesale distributor of industrial and construction supplies, up more than 36% year-to-date, is another example of a stock due for a pullback. In this case, it could simply be valuation: trading at a forward P/E of 25, this industrial stock is anything but cheap. (If you own shares, keep in mind that the company just announced a two-for-one stock split, effective at the market close on May 2. At that time, holders of record will receive one additional share for every share of FAST they own; the share-price will start reflecting the split on the next business day).
Action To Take
Finally, remember: Taking a gain on a winning stock is a defensive measure. This action frees up some cash in addition to making sure your gains are protected from the market's whims. Of course, there could be an opportunity cost if the market rally continues -- so make sure you weigh your goals and your risk tolerance carefully before pulling the trigger.
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(This article originally appeared on StreetAuthority.com.)