Is the Stock Market Overheated? Here's my Plan...

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As themarket rises steadily higher, it's getting harder to find true bargains. And though a wide range of good stocks still have reasonably-pricedshares , any market pullback would send most stocks lower from their 52-week highs.


 

This backdrop has led me to start raising cash in my $100,000 Real-Money Portfolio . One of my top rules of investing is to always have funds available if you think the market may soon present fresh opportunities.

Even as I see a moderate pullback coming, I may be wrong. The market may indeed march ever-higher. And that's OK. I still have 85% of my funds invested (albeit with one position representing a markethedge ). So I'm likely to benefit from any upward move in the market as well, just not to the extent that a fully-invested risk-focused portfolio may benefit.



As I stated at the launch of my $100,000 Real-Money Portfolio , I seek to preserve capital while in the process of building it. This approach is bound to modestlyunderperform in a ragingbull market , but it should also fare better in a flat to down market. Indeed, with all of my picks, I focus on "downside protection." Every pick was made in the context thatshares were likely near a floor in case my investment thesis didn't pan out or the market turned south.

Of course several of my picks no longer have such downside protection in place. For example, Cree (Nasdaq: CREE ) and Ligand Pharmaceuticals (Nasdaq: LGND ) have moved up nicely since the year began and can no longer be seen as having much downside support. That said, both of these companies have such robust long-term growth prospects, that I simply have to shoulder the risk.

What to buy now?

Despite my concerns about a possibly over-extended market, we're about to face a fresh buying opportunity. In coming weeks, I'll be focusing on "earnings season casualties." These are companies that deliver tepid quarterly results or proffer weak forward guidance. Investors often overshoot the mark in their zeal to unload these kinds of stocks, and they can end up as fresh, solid long-term value plays. The problem with these stocks is that it may take a quarter or two for their value to be appreciated by investors. That's why I'm unlikely to ever put more than $5,000 in any initial position.

I currently have about $13,000 in available cash. Frankly, if the market keeps trending higher by the timeearnings season begins around April 10, I may sell some more stock to give me even more cash with which to work.

What to expect thisearnings season ?
I've separated my holdings into two camps in my portfolio: those stocks that will largely be unaffected by earnings season , and those that could make strong moves.

In the first camp, you have steady-as-she-goes stocks like Hasbro (NYSE: HAS ), Ford (NYSE: F ) , Alcoa (NYSE: AA ) and Citigroup (NYSE: C ) . We have a pretty clear read on industry conditions for each of these firms, so anearnings shocker is quite unlikely. (I'll be looking at bank stocks and the coming quarter later this week, and suspect that Citigroup's reboundingcapital markets division should lead to moderate quarterly upside for the banking giant.)

On the other side of the coin, I hold stocks that could quickly move higher or lower in coming weeks. For example, shares of Cree have risen more than 30% since the year began, even though the first quarter is likely to be either in-line or below consensus forecasts. The LED-lighting industry dynamics are clearly improving, but you won't see that until the June quarter or beyond. Still, I am sitting tight on this high-growth stock.

Ligand Pharmaceuticals is another vulnerable holding. This biotech firm is gaining a following onWall Street , pushing its shares up to two-year highs. I expect this stock to be much higher over the long haul, but if it makes a dash into the $20s in coming weeks, then I'd be inclined to sell off half my position. Then again, a weaker market could push this stock back down, in which case I'd be sitting tight.
  
Action to Take --> Before earnings season gets underway, I'll be providing a much more in-depth preview for several of my holdings. Stay tuned, because knowing what to expect may help you to move quickly as the quarterly numbers are formally released. [And by that token, if you haven't already signed up to receive my $100,000 Portfolio updates in your email inbox, you can do so by clicking here . It's completely free for a limited time.]


-- David Sterman

David Sterman does not personally hold positions in any securities mentioned in this article. StreetAuthority LLC owns shares of CREE, HAS, AA, C, LGND, F in one or more if its "real money" portfolios.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.


This article appears in: Investing , Basics

Referenced Stocks: AA , C , CREE , HAS , LGND

David Sterman

David Sterman

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