Facebook Twitter



Oh, what a glorious ride this year's stock market has been. With the Dow Jones up nearly 25 percent year-to-date, it is hard to find any unhappy domestic stock market investors. That is, as long as the stock market continues to climb.

Over the last few weeks, a few disturbing signs of a potential correction have developed and mutual fund investors should ask themselves under what circumstances would they sell. Even if you are a die-hard buy-and-hold investor, I encourage you to read on and rethink if you want to hold through a correction.What has me worried?

1. TECHNOLOGY UNDER-PERFORMS THE DOW. I consider the health of the technology market to be a very accurate gauge of the stock market's direction. When the technology sector is outperforming the Dow Jones, the stock market is usually beginning or in a strong bull market. Intuitively, that should make sense to you.

Technology stocks, are by nature, more speculative and volatile than blue chip stocks. Investors only flock to technology stocks/-funds when they are very confident that the stock market is poised to go higher.

Conversely, investors avoid technology stocks/funds when they anticipate a bear market because technology stocks will lose money at a much faster rate than blue chips.

Last week, the relative strength chart of technology vs. the Dow Jones went negative. Over the last three weeks, the Dow Jones has been outperforming the technology sector.

2. ROTATION TO DEFENSIVE STOCKS. A "defensive" stock is a company that manufactures something you can eat, drink, smoke or use in the bathroom. The conventional wisdom is that no matter how bad the economy or stock market gets, we all have to eat, drink, use the bathroom and indulge our addictions. Investors start to move into these defensive stocks when they feel the stock market is vulnerable.

Of all the Fidelity Select sector funds, which one do you think is the very top performer for the month of September? No, it isn't Select Technology, Multimedia, or Computers. The top performing Select fund in September is Fidelity Food & Agriculture. Yes, a fund filled with RJR, Ralston Purina, Quaker Oats, Phillip Morris, Tyson Foods, Pepsico and Nestle is beating the pants of semiconductors, computers and software.

3. INTEREST RATES STALL, FORM DOUBLE TOP. Much of 1995's bull market can be attributed to declining interest rates. Everyone understands how declining interest rates are good for the stock market. Conversely, rising interest rates are very bad for the stock market.

You'll have to take my word for it since you can't see the chart of the 30-year Treasury bond (unless you subscribe to Donoghue OnLine, my electronic mutual fund database, 800-982-2455), but the long bond has formed a double top. Yields have stubbornly refused to drop below the 6.45 percent level, forming a significant resistance area.

Unless the bond market can punch through this important resistance area, it is likely that interest rates will rise and put pressure on stock prices.

4. RISING COMMODITY PRICES. The Commodities Research Bureau's (CRB) index has recently hit a five-year high. That means that prices, at the wholesale level, have been rising. Ultimately, the price increases will work their way into the price of finished goods. That forebodes poorly for the inflation rate and may make it difficult for the Federal Reserve Bank to lower interest rates further.

The CRB index is, however, heavily weighted toward agricultural products and underweighted in the industrial commodities like copper, petroleum and aluminum.

DON'T RUSH OUT AND SELL. Don't get the idea that I am recommending a blanket sell recommendation. I'm not. In fact, my clients are still substantially invested in the domestic stock market (call 800-642-4276 for information about my managed account service). I do believe that the domestic stock market is still headed higher.

However, there are enough telltale signs of a trend reversal that I have my finger on the sell trigger. Meanwhile, my clients and I are enjoying a great bull market and the profits that come with it. Yes, be worried, but no, don't run for the hills just yet.