When is it a good time to sell stocks? There is certainly a case to do so now.
The major indexes have surged these past two years. The Standard & Poor’s 500 index gained 25.3 percent in the 24 months, while the Dow Jones industrial average grew 33.3 percent. That equates to annualized returns of approximately 12 and 15 percent, respectively. None of the figures include dividends.
Plus stocks are looking pricey. The cyclically-adjusted price earnings ratio, which was developed by Nobel laureate Bob Shiller, is at 30.4. The reading has been higher only twice in history, during the tech bubble in the late 1990s and early 2000s; and just before the great depression of the 1930s.
“P/Es are very high. With that there is a very good reason to cut back on stocks,” says Vincent Catalano, global macro strategist at Blue Marble Research in New York. But that doesn’t mean dumping all your stock holdings.
[See: 8 Times When You Should Sell a Stock.]
“Be prudent and reduce to a degree and looking to rebalance portfolio going forward,” he says.
For instance, the surge in stock prices may mean that you now have a larger allocation to stocks than you desired and likewise a smaller portion of bonds. If that’s the case, then sell some of your stocks, such as those held in the SPDR S&P 500 (ticker: SPY) exchange-traded fund that tracks the S&P 500 index. Then use the cash to buy some bonds, such as those held in the Vanguard Total Bond Market ETF ( BND). The Vanguard fund tracks a broad basket of bonds.
The two funds have annual expenses of 0.1 percent and 0.05 percent respectively, or $10 and $5 per $10,000 invested annually.
Another solution. Not everyone sees cutting back on stocks is necessarily the right thing to do.
“If you think it’s time to trim, that means that you think we are approaching a top; and we think that is a pretty darn difficult thing to pull off,” says Terry Gardner, senior managing director at CJ Lawrence in New York. “You are taking an awfully big bet that you know how to time the market.”
It’s tricky to time the market. Not only do you have to know when the market has finished rallying, but you also need to know when to get back into it. Most finance professionals can’t do this consistently. The rest of us probably have no chance.
[See: 9 of the Market’s Best Growth Stocks.]
“We advocate rebalancing and reallocating,” he says. “If you have outsized weightings then we are all for moving money between sectors.”
For instance, if you invested a small portion of your portfolio in defense stocks a year ago, you would have noticed that they have outperformed the overall market by a large margin. The iShares US Aerospace & Defense exchange-traded fund ( ITA), which tracks a basket of defense and aerospace stocks, is up 28 percent, versus 13 percent for the S&P 500.
If that is the case, then reallocating some of the profits to sectors that have lagged make sense. For instance, over the same period The Energy Select Sector SPDR Fund ETF ( XLE), which tracks a basket of energy stocks, fell over the same period.
This technique of selling some of the winners and buying some of the losers benefits from mean reversion. That’s when the return on various stocks comes back to a long-term trend rate over time.
Still bullish. Some people don’t think there’s a need to worry. “I don’t think stocks are overvalued,” says Peter Morici, professor of business at the Robert H. Smith School of Business at the University of Maryland. Interest rates are still low by historical terms. The result of this is that the high price-earnings ratios for the market are not a problem, according to Morici.
[Read: North Korea Standoff: How to Invest in Defense Stocks,]
He also says investors should shrug off worries that are currently dominating the news. “We’ll get through the North Korea thing and the debt ceiling battle, and the president isn’t going to cut trade [with China] because of North Korea,” he says.
So the best advice is to sit tight with your investments, because most of what we worry about doesn’t come to pass.
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When Should I Sell Stocks? originally appeared on usnews.com
