NEW YORK (CNNfn) - As fall coolness creeps into grayer days, it seems like summer has sped by along with three-quarters of the year. But that, stock-watchers say, makes it high time for a fall cleaning.|
Time to sweep through that portfolio and cast out the junk. Your investment bundles may need a little tidying, too, planners suggest.
Chances are, looking at your portfolio is a lot less pleasant than it was this time last year. Nasdaq was beginning a tear that lasted into April.
This year, the top performers have been out-of-favor value plays like utilities, energy stocks, real-estate investment trusts, financials and certain health-care stocks.
Charles Schwab, chairman and co-CEO of the brokerage that bears his name, told CNNfn's television programming that he believed the market still had a few swells in it the rest of the year.
"It's been pretty gruesome here in September, and probably October is going to be a little rough, too," he said.
"Before we get the elections behind us, I think it's going to be rough waters."
Schwab also spoke with CNNfn.com to give his perspective on what investors should do to reposition in the fourth quarter, among other topics.
A good spot to build
But he and financial planners say the skepticism investors now have about the market is in fact a good platform on which to build.
It might not be as pleasant as you'd hoped to hash over your brokerage statements. But the end of the year makes for a natural time for a review. So too do the choppy markets. It's also good tax-planning time.
"This is a good time [for review]," said Hugh Johnson, chief investment officer with First Albany. Perversely, the uneven U.S. markets make for planning opportunities.
"Even though it's a bad time, it's a good time - if you have a taxable account, you clearly want to harvest some of the gains, and offset it with some sales of losses," Johnson pointed out.
Will 'unsexy' sectors keep their steam?
Market watchers like Johnson credit the success of utilities and real-estate investment trusts, or REITs, to the fact that they hold up well in a slowing economy. There are added attractions - many pay hefty dividends. They're sometimes viewed as inflation hedges, though inflation has been more a threat than reality.
So higher interest rates and stagnancy for volatile sectors like techs drove investors toward safer investments that are producing income now. But that outperformance may well not continue if earnings roar off or the markets shift again next year, experts say.
"If we do see a rally, some of the stocks that have done well may not do as well," advised Scott Kahan, a certified financial planner and president of Financial Asset Management in New York.
Instead of chasing returns, he encourages investors to take gains in the sectors that have held up. Then he recommends repositioning in stocks that have underperformed this year.
"That would include some of the technology stocks," he said. Many big-name stocks have suffered disappointments this year, such as Lucent (LU: Research, Estimates), AT&T (T: Research, Estimates) and Intel (INTC: Research, Estimates).
Intel, at 25 times 2001 earnings, may still not be incredibly cheap, even after it lost 28 percent in one day after its earnings-warning shock on Sept. 21. But stocks like Intel and Lucent are a bargain compared to their historical trading range, Kahan said.
"I think they're good companies. They're not going anywhere, not going away," he said. "Sometimes a stock gets beaten down, bid down, more than it should be."
He doesn't expect an immediate rally, either, but long-term investors can get a discount on what he expects to be a solid buy-and-hold play.
Time to cut your losses
Investors are clearly not confident at the moment, and the market has moved sideways the past six months. Most investors feel better chasing the pack, Kahan said. But the best returns come from being near the leaders, he pointed out.
The planner suggests investors who are repositioning in taxable accounts offset gains them with capital losses, by selling bad investments.
"People get emotionally tied to investments and they don't like to sell them," he said. Then they hold the loss for a while and figure, 'Well I've held it this long ...' he said.
"If you're not willing to invest more in it, maybe you should sell and invest somewhere else," Kahan said. Admit your bad investments, he recommends, and let Uncle Sam share some of the brunt with the tax break.
Watch wash sales and offsetting losses
One consideration when you rebalance is the wash-sale rule, according to Phil Cook, a certified financial planner in the Los Angeles suburb of Torrance, Calif. Occasionally he has clients that sell a loser purely for the tax break, planning to repurchase it.
But if you sell a losing investment to capitalize on the loss, you have to wait 30 days before buying back the same or a similar investment. The idea is to prevent investors racking up "losses" to offset capital gains every time a stock dips, then buying the same stock immediately.
Of course, long-term capital gains - taxed at 20 percent for most people - only apply if you've held an investment longer than a year. Otherwise you'll pay regular income tax, normally higher than 20 percent, on a short-term gain.
It's best to offset long-term capital gains with long-term capital losses and short-term capital gains with short-term capital losses, Cook said. Though both types of loss are treated the same from a tax standpoint, gains are not. And short-term losses offset short-term gains first, then count against long-term gains.
So a short-term loss is "worth" more to an investor if it is offsetting a short-term gain taxed at a higher rate - 36 percent, perhaps. Otherwise you're offsetting it against a 20 percent tax rate.
Tax selling shouldn't come first
The economics and stock fundamentals always come ahead of tax-planning considerations, though, Cook chastened. If you have no capital gains to offset, he added, you can only claim up to $3,000 in capital losses against ordinary income. The rest of the loss will be carried forward.
Cook points out that there's a lot of talk about seasonal investment factors toward the end of the year. December, January and November, in that order, have been the strongest months for the S&P 500. Market watchers credit bonuses being paid around then and new 401 (k) money coming into the market.
But there may be tax-selling-related weakness heading into those months. It's also an election year. The market tends to "vote" Republican, with a slight rise in the market around a GOP presidential victory, according to New Jersey-based stock market historian Yale Hirsch and the Stock Trader's Almanac. There is a slight dip when Democrats win, though President Clinton bucked that trend in 1996.
More significantly, the May-to-December period of an election year has produced stock market gains every election from 1952 to date.
Cook cautions his clients to ignore many of those trends. Even if there are good reasons for such investing "urban legends," that kind of thinking leads to market timing, which Cook, like many planners, avoids.
Have you reached your goals?
He thinks investors should review how they think the economy and their holdings will proceed next year. Have your stocks reached the price targets you set? Have the underlying arguments for holding the stock changed?
If investors are confident earnings will strengthen next year, Cook suggests moving toward aggressive growth stocks. If you haven't already, review next year's earnings prospects for your own stocks, he suggests.
When it comes to a factor like interest rates, it's very hard to look ahead. "It's almost impossible to forecast what's going to happen. Not almost - it is impossible," Johnson joked.
Cook predicts that mid- and small-cap companies will continue their recent run. "Large caps are pretty much valued out," he said. Investors "might want to think, since I'm selling this [stock] for a tax loss, I want to allocate more money to the mid- or small-cap sector."
Johnson agreed the mid- and small-cap rally is interesting. Traditionally, in fact, small-caps tend to rally toward the end of a year.
But this rally "is not lop-sided and it is not all that decisive," Johnson said. He is watching for proof smaller stocks are outperforming consistently.
Johnson added that, while big-cap names like Sun Microsystems (SUNW: Research, Estimates) and Cisco Systems (CSCO: Research, Estimates) are costly on a price-earnings basis, it's not a given they are overvalued. They are expensive. "But that is not the reason that you sell the stocks," he said.
"Let the market tell you what to do"
Sell when their relative performance (compared with the S&P 500) is below-average, he said. That shows OTHER investors, and the market, thinks the stocks are overvalued.
"You have to be careful about prejudging this - I've seen so many investors burned at the stake thinking things like 'Value is about to come back,'" Johnson said. "Let the market tell you what to do. Don't tell the market what to do."
He said First Albany is overweight in several sectors where he thinks the performance will be strong next year - technology, energy, health care, industrials and utilities.
He recommends that investors decide where to overweight. "Asset allocation and sector performance will determine your returns," he said.
Last year's free ride seems to have reached the end of the line. One thing's for sure -- 2000 has rammed home, sometimes painfully, the importance of diversification.
"The end of the year is always a good time to decide on what you've learned and play that knowledge going forward," Cook said. Review your portfolio and see if it still fits with your strategy and risk profile, he suggests.