Use The Summer Rally To Get Out

Includes: DIA, QQQ, SPY
by: Dante Caruso

The current market is starting to feel like 2000 in some ways. Stocks like Tesla (NASDAQ:TSLA) have tripled in months, Amazon (NASDAQ:AMZN) is leading the new highs, and NYSE margin debt is again at or near record highs.

In other ways, the world is much different. Crude oil has quadrupled since then, and has redirected enormous wealth away from developed-world consumption. Central banks of developed countries are taking extreme measures to patch long-term structural problems with short-term solutions.

Valuations are not quite as stretched now as 2000, but any similarity to that bubble should give investors pause. Here's a personal experience from 2000 than may help clarify the similarity between then and now:

During the market decline in May of 2000, I bought the Semiconductor Index (NYSEARCA:SMH). It had underperformed technology in general, and seemed to offer relative value. At the time, every analyst was bullish on semiconductors (something that should obviously have been a warning sign). But there was one particular facet to the idea that I finally succumbed to: there was supposed to be a shortage of semiconductor chips in the second half of 2000. Apparently, there was just no way to meet demand, and the semiconductor industry was scrambling to figure out how to cope with the orders.

The Nasdaq Index (NASDAQ:QQQ) peaked in March of 2000, and the Semiconductor Index peaked with it. There was a nice rebound into September, but it was just a trap for the dip-buying public that had been repeatedly told to "dollar-cost-average". fell by more than 50% by year-end.

There is a simple moral to the story: the worst time to buy the in the last 20 years turned out to be the time when the news was the most bullish. Another lesson from the experience was that trying to hide in "value" from a market downturn was not effective. Sometimes it is best to sit and wait for better opportunities.

After 2 brutal stock market drops in the last 12 years, I never would have believed investors would have the stomach to again drive valuations to current high levels. The S&P500 (NYSEARCA:SPY) is price to sales is 1.55, closing in on the extreme levels of 2000:

S&P500 Price to Sales Ratio @

While debates are raging today as to whether the current market is overvalued, all I can tell you is that there will always be someone to offer you rope to hang yourself. In 2000, the analyst community figured out that rising rates were not bad for technology stocks because very few had any debt. As a result, technology stocks rode a wave of investor enthusiasm while dividend-paying stocks underperformed.

There are seductive arguments for the current market, for example: QE and not fighting the Fed, lack of alternatives in a ZIRP-world, the slowdown in China is allowing for disinflationary growth, and a U.S. manufacturing advantage from cheap natural gas.

You somehow have to see through the noise and realize that the current market is populated by late stage investors. The lure of late-stage stock market gains is that there is always time to get out. The exit door is dynamic; the size of the exit is determined by the number of people that populate the identical investment thesis.

Consider the stereotypical nightclub fire: in the nightclub before the fire rages. If there were only 8 people in a nightclub with 4 exit doors, and a fire broke out… how many people would escape death?

If there is only one chart I would recommend an investor see it is NYSE Margin interest. It is one of the best ways to know how crowded your investment thesis "nightclub" is:

Bloomberg chart May 2, 2013.

The above graph underscores the distinction that as a stock investor, you are not playing against the data "the house", you are pitted against other shareholders. As in poker, your ultimate gain is not judged by the cards you hold, but by the relativity of those cards as compared to others'. With margin interest at or near an all time high (as shown above) you are now holding stocks against the most fickle of investors- ones who are holding with borrowed money, and could turn to sellers at the slightest hiccup.

That the merits of an investment in high-flyers such as Netflix (NASDAQ:NFLX), Amazon, or Tesla are actively being debated at this time shows you that nothing ever changes- particularly in the stock market- a theme uttered by Jesse Livermore over a century ago. Studies have shown that boring, utility-like stocks beat high flyers over time.

If the current raging debate was whether or not it makes sense to ride out the next, inevitable market decline with large cap dividend payers, knowing that a decline of at least 30% is probable, if not likely, then I would conclude that key lessons have been learned. But that is not the theme of the day.

If you are clever enough to ride this market with one hand on the exit door, knowing that you will be able to exit, then I admire your courage. But, by definition, everyone cannot get out at the high. Good luck and best wishes in the effort.

While most observers seem to think the Fed stimulus is sure-thing for the stock market, I see it as fully-discounted in current valuations. This is the most stimulus-dependent market in modern history. Does that really sound like a great reason to buy, or perhaps reason for caution?

The two stock market dives since the turn of the century happened during aggressive Fed easing. Fed actions should not be the sole cause for comfort or complacency. Corporate profits are a reason for outright concern:

Corporate Profit Cycles by John P. Hussman, Ph.D.

Note that there is always a seductive reason to allocate money into stocks, and this time is no different. Now we apparently have to accept that cyclical nature of corporate profitability is finally cured. In other words, this time it's different. Corporate profits will eventually trend back toward historical norms and make current valuations will look expensive by comparison.

I recommend that you find a safe investment of the cash-like variety, like the Vanguard Short-Term Investment Grade Fund (MUTF:VFSTX), or defensively postured, like the Hussman Strategic Dividend Value, (MUTF:HSDVX) or Hussman Total Return Fund (MUTF:HSTRX) in an environment like this. Think in terms of retaining purchasing power for when stocks are finally offered at significant discounts to current prices.

While I continue to hold silver (NYSEARCA:SLV) (NYSEARCA:PSLV) because some of the commodity markets are possibly at a cyclical low during a secular commodity bull market, it is certainly possible that whatever conditions eventually cause a selloff in equities also drag precious metals down for a period of time, as they did in 2008. Precious metals may also shrug off a decline in stocks and continue to trend opposite stocks as they have for most of the past 2 years.

Keep an eye on leading stocks like Home Depot (NYSE:HD) which may soon start to top out and decline on heavy volume. Momentum loss in leading sectors combined with heavy volume declines would signal that there is little remaining time to move completely to the sideline, hedge longer term holdings, or place short bets at optimal prices.

Stand by the exit door.

Disclosure: I am long PSLV. 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.