October 16th, 2009

Begin Pruning, Trimming and Weeding Your Portfolio

Readers here know that I’ve long thought that the market was going to run into resistance, start to consolidate this long bull market somewhere around 1100-1150. For example, in the discussion section of my Facebook page, I wrote on August 5, “I see a run up from current levels starting around Labor Day that will carry Index to a 2009 high of 1150, or up 15% from current levels.” On that day, the index closed at 1002.72; Wednesday’s close was 1096.56.

We’re only 5.5-6.0% away from that mark, only a couple of good trading days as sidelines money makes a mad dash in the form of a blowoff top, a “steep and rapid increase in price followed by a steep and rapid drop in price”, according to Investopedia. If it happens, there will be even more confusion and mixed signals than Cramer’s double message (sell if you have profits; buy if you still have funds on the sidelines).

You’ll hear talking heads start declaring the market might even climb all the way back up to 1350-1400. There will be talk of corporate spending on the increase, employment starting to rebound, the second wave of defaults (option ARM mortgages) not being as bad as first feared, the commercial real estate crises begin averted and a growing concensus that a weak dollar actually reducing the market’s P/E by the higher foreign profits it produces.

But rather than being too doctrinaire, I’m beginning to think that now might actually be a good time to start “pruning” your portfolio. Begin trimming stocks you added during the run up since March-April that haven’t performed that well; if they have grown less than the market has while you’ve owned it, they probably won’t do better than the market in the future. Rebalance the portfolio by reducing the exposure in stocks that have significantly out performed the market and now represent too large a percentage of the portfolio.

Rather than thinking of these moves as “selling” the market, clearly a defensive move, view it as an offensive strategy, beginning to prepare for next leg. Funds generated through this “housecleaning” can either be held as cash or you can add to those remaining positions that are still working nicely and have room to grow (i.e., not bouncing up against resistance in the form of trendlines or moving averages).

Now is the time to start the process. If you wait until the market actually starts topping off you’ll be confused, befuddled, fearful of missing some of the action, leaving money on the table. In the same way that we cautiously took incremental steps rather than jumping all the way at the beginning as confirming signs presented themselves, we have to begin taking incremental steps as we approach the top.

Rather than picking low hanging fruit, we’re trimming the bush and prunning the tree of dead branches. Now is the time to start cleaning up to prepare for the next season.

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