How to Invest in an Aging Bull Market

The U.S. economy shrank in the first quarter. The Russell 2000 index of small companies tumbled nearly 10% this spring. High-octane "momentum stocks" likewise got clocked. And the bull market is now the fourth-longest since 1928. Time to sell stocks?

Not so fast, says Jim Stack, editor of InvesTech Market Research Analyst, who's advising subscribers to put 82% of their investments in stocks. Stack, in my view, has sound reasons for being bullish. What's more, his record offers a reason to take his market calls seriously.

Calling market turns is a perilous business at best, and Stack has made mistakes--most significantly becoming bearish too early in the 1990s. But his long-term record is superior. Over the past 15 years through April 30, the authoritative Hulbert Financial Digest reports, Stack's model portfolio returned an annualized 8.5%, compared with 5.0% annualized for the Wilshire 5000, a measure of the broad U.S. stock market. Stack was also on target about the onset of the bear market on October 9, 2007, and about its conclusion, on March 9, 2009. He's been (correctly) bullish ever since.

Stack employs both economic data and technical analysis to make his market prognostications. Here's what he sees now:

Stock market breadth. Many more stocks are rising than falling. Technicians like Stack read that as a bullish sign. Likewise, far more stocks are setting new 52-week highs than new lows--another healthy sign. What's more, an index Stack has compiled of stocks that he says tend to lead the market has been making new highs.

Market advances are inclined to become increasingly narrow when bull markets are drawing to a close, technicians believe. Such a bearish development is nowhere on the horizon, Stack says, despite the recent weakness in small-cap stocks. The blow-off of high-octane tech and biotech "story stocks" in March and April, Stack says, dealt a blow to market excesses. "You need those kinds of corrections to temper speculation."

A slowly growing but improving economy. Yes, economic growth remains achingly slow, but Stack sees this as bullish: A slow recovery makes it less likely that the economy will overheat, leading to an increase in inflation. But the decline in gross domestic product in the first quarter at a 1% annualized rate was almost certainly due to weather.

Data from the Institute for Supply Management surveys show increasing growth both in the service and manufacturing sectors. The Conference Board's measures of consumer confidence, CEO confidence and its leading economic indicators all point to economic expansion.

The market's technical and the positive economic signs suggest to Stack that the bull market is in no imminent danger of ending. Historically, he points out, the end of bull markets tend to be slow, rounded affairs. That means you don't need to sell stocks the first week the market declines to avoid getting clocked. (New bull markets, by contrast, typically take off like rockets.)

Not that Stack doesn't see negatives. Here's what worries him:

The bull market's age. In investing, patterns tend to repeat. Since 1928, only three bull markets have lasted longer than the current one, which is nearly 63 months old. "Bull markets don't die of old age," Stack says, but as time goes on, the odds against their continuation lengthen.

Housing weakness. Sales of existing homes and other housing indicators rebounded after the Great Recession ended, but they have been weak of late. Part of that was due to the bad winter, but further declines could increase the odds of a recession. Housing and related spending account for almost 20% of GDP. What's more, housing can have a big influence on overall consumer confidence. Even homeowners who don't plan to move tend to cut back on spending when housing prices fall in their area.

Margin debt. Margin debt, money borrowed in brokerage accounts (and often used to invest more heavily), has dipped from near record highs in recent months. High levels of margin show increased speculation in the market. When margin begins unwinding from high levels, stocks often fall.

Stack's best guess is that the bull market will end sometime over the next six to 24 months. What's worse, he expects the next bear market to be doozy.

From the start of the bull market through June 3, Standard & Poor's 500-stock index has delivered a total return, including dividends, of 218% (or 24.7% annualized). Since 1928, every bear market save one, Stack says, has taken back more than half of the prior bull market's gains. That's sobering.

What to do now? Rather than selling stocks, Stack recommends that you emphasize sectors that have historically done well both in the final 12 months of a bull market and in bear markets: energy and health care. Stack's recommended portfolio also has big positions in consumer staples, which often do well in down markets, and technology, which tends to outperform in the last few months of bull markets.

Stack currently recommends that fund investors put 82% of their money into various SPDR-brand, exchange-traded sector funds. His biggest positions are in Health Care Select Sector SPDR ( XLV ), 14%; Consumer Staples Select Sector SPDR ( XLP ), 13%; Financial Select Sector SPDR ( XLF ), 12%; and Energy Select Sector SPDR ( XLE ), 11%.

Frankly, I think Stack's approach is a little too cute. In my view, the safer course is to stay invested, but load up on stock funds that invest in lower-risk blue chips that have a history of holding up well in bear markets.

Steve Goldberg is an investment adviser in the Washington, D.C., area.

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

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

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