Strategy for a twitchy market

Strategy for a twitchy market. Many investors are deeply suspicious of the 60% run-up in stocks this year and are itching to sell. But then what? Here's how to take some gains now while setting up a profitable 2010.

Feeling twitchy?

Your portfolio is probably full of stocks trading at 52-week highs, and a correction seems overdue. I'll bet you've thought about selling.

And you would do that -- except the stock market keeps going up, cash pays close to nothing, and it's hard to find a stock to buy that's not already trading at its 52-week high.

What to do? Let me lay out a three-part strategy for you and suggest a few stocks with strong fundamentals and good upside potential in 2010.

1. Build a cash management plan -- and put it to use

There's a huge difference between sitting out a nasty correction with all the money you had budgeted for college tuition, an annual tax payment or the down payment on a house safely in cash and having to liquidate investments at fire-sale prices and scrambling for cash. The last thing you want to do in a downturn is to take a big hit on your portfolio and then wind up losing a real-estate deal or having to yank a kid out of college.

If you're nervous about the next six to 12 months, cash out the money you anticipate you'll need over that period at prices that are today 60% above where they were in March. If you have to keep $60,000 in cash so that you can sleep at night knowing that you've got your financial bases covered, then the loss of a potential gain on that money is worth it. I've sold into this rally to sock away my kids' tuition for 2010 and my tax payment for next year. The cash is earning close to nothing, but the peace of mind, I've found, more than makes up for the lower return.

2. Accept that momentum is real -- and can be your friend

Over and over during this rally, I've heard from investors who have said, "The stock market is ahead of the fundamentals of the economy," or, "This rally is built on nothing but the world's central banks flooding the financial markets with liquidity."

I totally agree. This is a liquidity-driven rally. It's based on the huge influx of cash from government stimulus programs in countries such as the United States and China. But that doesn't mean that any dollar you make in this rally is worth any less than a dollar made on virtuous fundamentals. And the idea that somehow by participating in this rally investors are destroying the republic, motherhood and the legacy of Warren Buffett and Benjamin Graham is, to my way of thinking, misguided. You take what the market gives you, and if it's a strong rally built on momentum, you say, "Thank you."

And the market's momentum is, at the moment, very strong. It looks like stocks have just successfully tested their October lows and have moved above their October highs. Since I wrote a blog post titled "You may not like the fundamentals, but this rally is headed higher" on Nov. 16, the major indexes have moved to within striking distance of a 50% recovery of all the ground that they lost in the collapse from the October 2007 highs. A move above what's called a 50% retracement would signal to technical analysts and momentum investors that this rally has further to run.

Technical analysis works because it summarizes in charts and figures the psychology of large numbers of investors. There is still a huge amount of cash on the sidelines, even after this rally. Much of that belongs to institutional investors who desperately don't want to fall any further behind the performance of the market indexes. So they'll put money into the rally because they feel they must. It's that feeling that the technical indicators are capturing right now.

And what will those investors buy?

They'll buy the stocks, especially the big stocks, that have been going up. They don't have time to wait for value stocks to show their value. They want performance now -- before the end of the year.

To take advantage of this momentum and this psychology, you, too, should buy the stocks that have been going up:

• Gold stocks such as Goldcorp, a Jubak's Pick, or Yamana Gold.

• Coal stocks such as Arch Coal.

• Technology stocks such as EMC or Corning, another Jubak's Pick.

• Mining stocks such as Vale or BHP Billiton.

The danger, if you're a fundamental investor, is that you'll fall in love with these stocks and be unwilling to sell them in cold blood at the first sign that their technical indicators are turning down. Fundamental investors tend (and I tend, to be honest) to justify holding on to a momentum buy even as the momentum fades because they believe in the company's fundamental story. In a market trading on momentum, great fundamentals won't save a stock when the momentum turns.

So how do you avoid this trap, one that's especially dangerous after a 60% gain?

Try exchange-traded funds, or ETFs. Sure, you may be susceptible to the lure of Deere's fundamentals, but bury Deere inside the Market Vectors Agribusiness ETFMOO) and the company is just one of a basket of stocks. It's easier to be coldblooded.

3. Consider buying the great fundamental companies of 2010 nowThe argument that this is just a momentum rally based on massive flows of global liquidity is based on two things:

Huge observed flows of capital. I don't think this is subjective or debatable. If you look at the money-supply numbers for China, the size of the global stimulus packages and the loose money policies of even the stodgy old European Central Bank, there's a tidal wave of liquidity driving markets higher.

A profound disbelief in an earnings recovery in 2010. This is subjective and debatable. We simply don't have the data yet to tell us how strong individual global economies will be in 2010. And we don't know how sustainable any economic recovery might be.

But we do know that the quarters of 2010 are going to be compared with some terrible quarters in 2009. In other words, it won't take much for earnings to look better on a year-to-year basis.

And we do know that some companies are coming out of this recession as lean, mean earnings machines.

Let's take a Jubak's Pick like Johnson Controls, for example.

Before this economic and financial crisis, the goal of the auto-interior business at Johnson Controls was global scale. The business unit could supply interiors for more than 30 million cars a year.

That was great in the days when vehicle sales in the United States were running at 16 million units and in Europe at 21 million units.

But when global auto volumes crashed, Johnson Controls lost money -- until the company took a scalpel to its cost structure. By the fourth quarter of its fiscal 2009, which ended in September, the company had reduced costs until it could now break even when industry production was just 8.3 million vehicles a year in the U.S. and 14.3 million in Europe.

That means this business was actually profitable in all geographic regions in the fourth quarter of fiscal 2009, even as the global auto industry continued to struggle to emerge from its deep recession.

If the auto-interior business was profitable when U.S. auto production volumes struggled to get back to 10 million units a year, think about the upside for this company with even a modest increase in production in the United States and Europe thanks to a below-average recovery.

In the first two quarters of fiscal 2009, Johnson Controls lost $1.03 and 33 cents a share, respectively.

In the first two quarters of fiscal 2010, Wall Street expects Johnson Controls to swing to a modest profit of 27 and 25 cents a share on the way to a 583% increase in earnings for the entire fiscal year. Fiscal 2011 is expected to bring an additional 38% increase in earnings. And those two years of amazing growth would take the company to earnings of just $2.06 a share in fiscal 2011.

I say "just" because in fiscal 2007, before the bottom fell out of the auto industry, the company made $2.13 a share. At its high in 2007, Johnson Controls traded at slightly less than $44 a share. The stock closed at $28.30 on Nov. 17.

I'd say there's some good gains based on fundamentals in this stock.

It's not easy finding cost-cutting, fundamental growth stories like Johnson Controls. Deere, another member of Jubak's Picks, is one. So is Caterpillar, as well as the stock I'm going to add to Jubak's Picks on Friday, Coach.

These also have the advantage that they have pretty good momentum behind them. ( msn.com )

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