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The market has been on a tear this year. The Dow has gained more than 9 percent since the end of December, and the S&P better by almost 11 percent over the same period, while the Nasdaq is closing in on a year-to-date gain of 27 percent. If you go back to October, the numbers are even more striking: a gain of over 25 percent for both the Dow and the S&P, and a 52 percent gain for the Nasdaq.
To paraphrase Cole Porter, this market's too hot not to cool down, at least temporarily.
But longer term there are some reasons to expect that this market will rally. First is human psychology. After three years of stinging losses, investors expect a rally, and may step up and buy stocks they feel have value, or have simply fallen too far. Second, interest rates on alternative investments have fallen so low that stocks look attractive in comparison -- investors generally look at return, not risk. Third, the new tax treatment on dividends makes the stock of companies that pay dividends look very attractive in comparison to those that don't, regardless of whether the market moves higher or not.
And there is an underlying economic reason to expect the stock market to rise: The economy is slowing but surely picking up steam. The second quarter saw gross domestic product rise 2.4 percent -- an improvement over the first-quarter's pace -- and growth estimates for the third and fourth quarter are 3 percent and 4 percent respectively. Economic expansion translates into increased sales revenues and a bigger bottom line for many companies.
But it won't be a broad rally. Most are cautioning that investors be very discriminate in their stock selection. The mantra this time around is high quality instead of new economy, with quality defined by many investors as companies with low share price volatility, higher dividend yields and consistent earnings growth.
In the meantime, though, this month might be a good time to add stocks, if you're so inclined.
It's hot and humid outside. The kids are still on vacation, and those of us that just act like kids are trying to get the very last drop out of summer that we can. And that's one of the reasons the stock market usually slumps in August.
With so many people taking time off, volume dwindles to nearly nothing, leaving few investors interested in supporting the market. According to the Stock Traders Almanac, August has been the worst month for the Dow Jones Industrial Average and S&P 500 over the past 15 years. And it hasn't been too kind to the Nasdaq.
One reason is that many portfolio managers start selling losing investments to offset capital gains. The tax year for most mutual funds ends on October 31, and they must do what they can to blunt their tax bill.
And this year, with the economic recovery still looking modest and interest rates rising, August may be an especially prime time for a modest correction that may afford you a much better entry price (and better risk reward ratio) for a longer-term investment.
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