The Day Ahead: When the Market Catches a Cold

 | Jun 12, 2013 | 8:00 AM EDT
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On May 21, every stock strategist was a heroic market top-caller. On that date, clients received an email advising them to hike the cash component of their portfolio, running down a list of reasons to sell, sell, sell.

Then we all woke up, realizing there was no email. If there had been any email that day, it would likely have detailed the reasons that the S&P 500 would reach 1700 by year-end.

At this point, these stone-cold realities absolutely must be understand.

Breakneck volatility has returned, and with that comes the slow erosion of investor confidence. Right now it appears Mr. Market is living and dying by the headlines, specifically Japan and interest-rate fluctuations on U.S. Treasuries. He is afraid to take all his chips off the table, because there have been a few positives of late -- for instance, Europe has improved since its weak first-quarter finish, and employment data has delayed any quantitative-easing tapering by Federal Reserve until later this year.

But, sooner or later, investors will have to seriously begin to position for the back-half of the year, and that's where the dilemma arises. Are consumer discretionary names being sold on fear of a global growth slowdown, and is there a rotation into defensives? Do you ramp up the amount of cash in your portfolio, opting to be reactionary as new trends emerge? (This would hurt the year-to-date bull run.)

Interestingly, among the management teams I have talked to post-earnings season -- at least among those companies doing well -- I've picked up almost this sense of continuing positive fundamentals. These companies have also conveyed that interest rates would need to creep even higher in order to trigger a dent in demand for their businesses.

With all that in mind, here are three concerns I have right now.

1. Companies in the S&P 500 carry an inflated forward price-to-earnings multiple in relation to historical norm. I'm also worried about forward indicators in various macroeconomic data points -- manufacturing, for example.

2. Where are the follow-through days after the market rips higher?

3. We're seeing hair-trigger sensitivity to any negative news, which hints that investors are just looking for a reason to sell.

So we can sit and opine on why Lululemon (LULU) CEO Christine Day opted to exit stage left. We can spin tales in our heads that, even though a position has gone 8% into the red inside of two weeks, that stock will valiantly fight back over the course of two days in a mega dead-cat bounce. In truth, individual stock stories are completely irrelevant at present. Yes, you heard that correct, champ. Either respect the market's message that it has caught a cold, or be left holding a basket of losers that -- according to your fancy spreadsheet -- all warrant above-market forward P/E multiples and earnings-per-share projections.

What to Do Now

First off, you must exit positions that are down 5% to 8% from the May 21 peak. The market is saying that the company's fundamentals, for whatever reason, are poised to decelerate enough to cause worry in coming quarters, and more quickly than in the broader market. A stock that's down 5% to 8% from the high could indeed have the bottom fall out of it. Chances are that it has violated key technical levels.

Second, tread lightly when it comes to enacting a bunch of short potions in order to snag some gains. The market has displayed crazy volatility and remains in an adjustment phase, meaning intense rips to the upside -- as seen last Friday -- are very possible.

Finally, find the forward-looking indicators of a company you own, be it on the balance sheet or an industry statistic. It's important to zero in on those numbers now, conceptualize how they will shake out for the second and third quarters and decide if the market has priced in a new trend.

For example, among homebuilder balance sheets, I am looking at the "deposits held in escrow" line as a guide to whether rising mortgage rates stand to derail the sector's comeback in the first half of 2014.

Your Next Dart-Throw: Aeropostale

I had a great conversation with Aeropostale (ARO) Tuesday -- my longtime contact there is always super nice and available.

Although the company will have more fashionable merchandise in its stores for the back-to-school season, I am concerned about Aeropostale's ability to regain lost market share from the likes of Urban Outfitters (URBN) (still a pick of mine) and various fast­-fashion retailers. The contact may have been trying to undersell me so that I would be wowed on the third quarter, but my takeaway was this: The company's long road to relevance among teen shoppers will be filled with many bumps.

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