The markets are off to a great start in January and many major indexes are near 5 year highs, thanks to a rise of about 5% in just the past month alone. The markets took off after leaders in Washington once again decided to kick the can on the looming debt crisis. It seems that politicians were equally afraid of letting the country go over the Fiscal Cliff and of the spending cuts that are needed to keep the United States from eventually turning into a Greece-like disaster in the future. Investors who don't take advantage of the recent rally and sell into strength might be missing out on a great opportunity to lighten up and put themselves in a position to buy the next market correction.
The relief and short covering rally we have experienced is likely to be temporary in nature for quite a number of reasons. Anyone who thinks that the last-minute deal made by Congress and the President to yet again delay dealing with the national debt and spending cuts is being short-sighted. It's like being at a party that you know is going to end, but at the last minute, the host brings out one more bowl of punch. Even if you stay longer, the party is going to end sooner or later. While there are always stocks worth buying and holding, the markets in general are overbought. With many daunting challenges, it is hard to see additional catalysts for the market rally to continue, and that means the easy money has probably already been made. The market will be facing a few major hurdles in the coming weeks and months. Here are four reasons to sell into this rally and take at least some profits now:
1. The United States is facing ridiculous debt levels, which have grown at an alarming rate over the past few years. Mike Stallings wrote an excellent article on this subject, and he points out that just a few years ago in 2007, the debt ceiling was $10 trillion. Now, the national debt is currently well over $16 trillion. It is also expected to keep rising to about $20 trillion by the end of Obama's second term. Some analysts are taking the debt threat seriously. A CNBC article quotes Barclays as stating: "We also believe that the market is underestimating the extent of the fiscal drag likely to prevail over the next few years."
2. Sequestration is looking increasingly likely to occur on March 1, 2013. This would impose major cuts in defense spending. Defense Secretary Leon Panetta was recently quoted as saying that allowing sequestration would "really be a shameful and irresponsible act." The defense industry would be significantly impacted, and these cuts would no doubt trickle into many other areas of the economy. There are estimates that the Defense Department would be hit the most by sequestration with 9.4% cuts, which are expected to cause hiring freezes, and across the board spending cuts that will impact defense contractors. Other government agencies are estimated to see across the board spending cuts of 8.2%, which is why this event could trickle into the economy at large.
3. Even though our politicians kicked the can by postponing the spending cuts and by suspending the debt ceiling until May, it won't be long before these realities come back. These issues are so difficult to deal with and agree on that Washington keeps trying to avoid it. We could be reliving the Fiscal Cliff issues in May, and that could, once again, impact the markets and the economy. If political dysfunction resurfaces over these issues, we could see another downgrade of the U.S. credit rating. Fitch Ratings recently warned that it would likely downgrade U.S. debt if lawmakers did not implement a credible debt reduction plan. The markets did see a short-term correction when ratings were cut last time, and that could happen again.
4. While fourth quarter earnings have generally been solid, that could change for a number of companies in the first quarter of 2013. This is because the payroll tax holiday that millions of Americans have been enjoying has ended. This has resulted in a 2% jump in payroll taxes, which many employees first noticed in mid-January when they opened their paychecks. This could begin to cause some belt-tightening, and lower consumer confidence in the coming months. It could also cause some businesses to become more cautious if sales are impacted. A recent Reuters article suggests that roughly 160 million Americans are now experiencing this tax increase, and it estimates that it will cost the average worker about $700 per year. This is money that is not likely to be spent at restaurants like perhaps McDonald's (NYSE:MCD), or on that extra cup of coffee at Starbucks (NASDAQ:SBUX). The Reuters article states: "The pain will trickle through the economy over the next few weeks."
It always seems that many investors are caught off guard each time the market has a meaningful pullback. It's easy to get overconfident when the market seems to go up almost every day in January. But with higher stock prices, more risk looms and so do many other problems. The stock market seems to be way ahead of itself right now, and it could be due for a correction soon. That doesn't mean it makes sense to sell all your stocks, but it does mean you should be asking yourself how you will feel if the market drops 5 to 10%.
I think it makes sense to avoid overbought stocks, which could be more prone to major declines, and focus on select trading opportunities, as well as on stocks that have strong balance sheets and lots of value. Apple (NASDAQ:AAPL) comes to mind since it has not participated in the recent rally. In fact, while many stocks are trading near 52-week highs, Apple is trading well below its 52-week high of $705 per share. Unlike the U.S. government, Apple has many billions in cash and no debt. It also can afford to raise the current dividend yield of about 2%, and do plenty more with the horde of cash it holds. Historically, it has paid off to buy Apple shares on major pullbacks that occur between new product cycles. That seems to be exactly what we are seeing now, and with plenty of growth potential remaining from the iPhone in emerging market countries and the possibility of Apple TV, it makes sense to use the current pessimism as a buying opportunity. One analyst at Barclays Capital (NYSE:BCS) thinks Apple will do well by introducing an "iPhablet", which is a cross between a iPhone and an iPad. This would be a hybrid smart phone with a closer to tablet-like screen.
Another cheap stock to consider thanks to a recent pullback is Corning (NYSE:GLW). This company makes "Gorilla Glass," which is seeing strong demand for use in smart phones and tablets. However, slow demand in flat screen televisions has stunted growth lately. Corning trades for just 9 times earnings, and it offers a solid 3% yield. It also trades below book value, which is $14.62 per share. Another big plus is that Corning has a strong balance sheet, with about $6.1 billion in cash and just around $3.46 billion in debt. Companies like Apple and Corning have the balance sheet strength to raise dividends in the future, and in a world full of government and corporate debt, investing in firms like these with strong balance sheets could limit portfolio risks for investors in a major market downturn.
Data is sourced from Yahoo Finance. No guarantees or representations are made. Please consult a financial advisor before making investments.
Disclosure: I am long AAPL, GLW. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.