NEW YORK (CNN/Money) - To buy or not to buy? For the average investor, that is the question.
The Dow is up 18 percent since Oct. 9 and the Nasdaq has surged nearly 25 percent. So it might seem like now is an opportune time to get back into the market. Stocks have momentum, with four straight weeks of gains. And the rally has been broad, with just about every major sector participating. It just feels like the market is once again becoming a safe place to put your money, right?
But you should probably think twice before you take all the cash out of your money market accounts and put them into an S&P 500 fund. Experts say that this latest rally could come to a crashing halt very soon.
Little has changed
We've been here before. Markets rallied sharply last fall after the Sept. 11 attacks and then cooled off and hit new lows by the spring. The major indexes went on a sharp tear in August as well but the late summer surge fizzled by September. And there isn't much evidence yet to convince money mangers that this rally is for real either.
|Help in a crazy market
"This is a classic bear market rally, a sucker's rally. There has not been anything good on the economic front to justify this run-up," says Steven Kaye, a certified financial planner and president of the American Economic Planning Group in Watchung, New Jersey.
So why have stocks been rallying then? Short sellers explain a lot of the boost, according to Richard Williams, managing director for research firm Summit Analytic Partners.
Short sellers borrow shares and sell them immediately with the hopes of buying back the stock at a lower price. So if stocks start rising, short sellers often have to buy back in droves to minimize losses. That has led to a big pop in the most downtrodden of stocks, especially techs.
But this wave of covering, known as a short squeeze, is usually temporary. And there's a flip side. Because many of the stocks that were heavily shorted have been bid up so much in such a short time, they become ripe targets for the short sellers again. Translation: more selling.
Williams says another factor boosting stocks is that mutual fund managers, most of whom are sitting on big losses for the year, are riding the wave of momentum and are buying stocks with the hopes of capturing some gains for the fourth quarter. That means that at the first sign of a market turn, mutual fund managers might dump a lot of stock they bought in order to lock in their gains.
Both of these phenomena show how sophisticated traders and money managers are trying to profit from short-term movements in the market. In other words, the individual investor that starts buying now risks getting caught in an avalanche of institutional selling. You usually don't want to be going in the opposite direction of an avalanche. "The average retail investor can't be as nimble as institutions. If you buy right now, you might be sitting on a loss for months," says Williams.
War and warnings equal pullback
So is there any juice left to this market rally? Perhaps. But things could change not too long after election results are official. Williams says that once the political dust settles, there is a good chance that President Bush will renew his tough talk about Iraq. And the prospect of war could have a big impact on the market, especially since oil prices would spike up.
Others warn that since the market has shot up so quickly, it is at greater risk of falling if earnings reports for the fourth quarter are not good. Sentiment can only prop up stock prices for so long. If companies don't deliver, you can kiss the rally goodbye.
"Once we hit the fourth quarter confession season, we'll see a pullback," says Joe Kalinowski, chief investment officer at Ehrenkrantz King Nussbaum. That's why Kalinowski says he is advising clients to buy select stocks and not make broad market bets. "There are opportunities but you just have to be smart," he says.
Two stocks in particular that Kalinowski likes are Wisconsin Energy, a regulated utility that has a dividend yield of 3.4 percent and Baxter, a medical device company that has fallen sharply due to some earnings warnings but that it is still expected to post an earnings increase of 14 percent this year and 13 percent in 2003.
Kaye says if your investing horizon is longer than eight years, he thinks some stocks make sense, particularly ones that pay dividends. The most important thing, though, is to have a diversified portfolio, he says.
If you're going to invest in stocks, be sure to have a mix of stocks and funds that represent many sectors of the economy. Don't go overboard on one stock or one type of company. That's the biggest mistake many investors made in the late 1990s, buying too much tech and not selling before the market imploded.
But if you need money for the next few years, you should probably avoid making many new investments in stocks, Kaye says. Cash and bonds are still the way to go for the conservative investor.