The Inconvenient Realities Facing Every Stock Seller

The Dow Jones Industrial Average bounced 45 points yesterday – lifting the index to a new 18-month high of 10,895. This achievement punctuates a dazzling one-year rally that has lifted the Dow more than 70% from its lows.

During the early days of this epic rally, bullish investors had both low valuations and an improving economic trend on their side. The price-to-earnings ratio of the S&P 500 index was about 40% below its five-year average. While at the same time, the worst of the credit crisis had seemed to have passed.

Today, however, the US stock market finds itself in a very different circumstance. Valuations are high and rising, despite the fact that the underlying economy merely muddles along…even on its best days.

In a New York Times article entitled, “Stocks Soar, But Many Analysts Ask Why,” reporter Javier C. Hernandez probes into this curious disconnect between an effervescent stock market and an economy “sin gas.”

“The unemployment rate remains locked in a range that recalls the economic doldrums of the early 1980s,” Hernandez observes. “Housing is stuck in a ditch, with foreclosures rising. And consumers are still reluctant to part with the little cash they do have. Yet the stock markets are partying like it’s 2003, when hiring was brisk, real estate was booming, wallets were fat – and the major stock indexes started a four-year rally that would double their value and push them to new heights…

“Autos, consumer electronics, regional banks and home builders – all losers in 2009 – have led the way,” Hernandez points out. “Banking stocks, which drove much of last year’s rally, continue to surge, with many regional banks up more than 40 percent.”

The relatively strong performances of these economically sensitive sectors tells us loud and clear that the stock market is relying more on hope than substance.

In the midst of such baffling conditions, almost no investor, least of all your California editor, can say whether it is best to increase exposure to the stock market or to decrease it. Nevertheless, your editor can say very confidently that he would rather be a seller than a buyer – not because it is the best thing to do, but because it is the least terrifying thing to do.

On the other hand, sellers of stocks face two inconvenient realities. First, they must pay taxes on their gains. Second, they must reinvest their proceeds in something else. And a brief analysis of the “something elses” that are available provides no comfort whatsoever. Real estate is still in the tank; commodities are as volatile as ever; and fixed income yields nothing.

Take your pick.

The good news is that these vast investment categories are not homogenous. Inside the asset class known as “commodities,” for example, we find everything from sugar to platinum to natural gas to burlap. Some of these commodities may soar in price over coming years and some may slump.

Obviously, this same dynamic operates inside every asset class: some real estate goes up, while the real estate goes down; some stocks go up, while other stocks go down. Therefore, the most pertinent question for long-term investors may not be whether to “sell stocks” or “buy stocks,” but rather, which specific commodities, assets or sectors to buy and which to sell.

Here at The Daily Reckoning, we like to conduct this analysis within an entertaining framework we call the “Trade of the Decade.” In other words, if you could bet on just one asset and or stock market sector for the next 10 years, while also betting against just one asset or stock market sector, what would these bets be? And why?

As faithful Daily Reckoning readers are well aware, both Bill Bonner and your California editor have already ventured their guesses about the best and worst investments for the next 10 years.

Now it’s your turn…

Welcome to the first-ever “Daily Reckoning Group Research Project” in which you, The Daily Reckoning faithful, may submit your selections for the Trade of the Decade.

Here are the ground rules:

1) Identify just one specific asset, commodity, stock market sector, currency, mutual fund, ETF etc. to buy and hold for the next 10 years. Please provide a symbol, if possible. But please do not provide the name or symbol of an individual company. (We are seeking to identify attractive asset classes, not specific companies.)
2) Identify just one specific asset, commodity, stock market sector, currency, mutual fund, ETF etc. to sell short for the next 10 years.

During his stint at The Rude Awakening, your California editor and his co-editor, Joel Bowman, conducted several “Group Research Projects.” In the very first Project, for example, we solicited the names of gold mining companies that might be acquired. In another project, we asked for the names of attractive oil and gas companies. In another, we solicited a “housing bust pair trade.” Admittedly, some of these research projects produced better ideas than others. But the exercise always seemed worthwhile.

So if you feel so inclined, please dive in and have a little fun. Who knows, maybe we’ll all learn something!

Eric Fry
for The Daily Reckoning