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Time to Take the Profit and Run?


In a market like this one, how should investors evaluate risk?

Curiosity is one of the most permanent and certain characteristics of vigorous intellect.
– Samuel Johnson

Over the past month, the market has been excruciatingly resilient. Since the June 24 low (1,573 on the S&P 500 (INDEXSP:.INX)), it has gained 7.5%. Last Thursday, the market took out the pivot highs set on the Bernanke "taper" scare. For most investors, the latest question lies within the black forest of doubt: How high is too high and do I get in now if I've missed the latest move this year? Or more to the point: Do I take my profits and run? Risk is relative to each individual investor; one need to ascertain these answers based on their willingness and acceptance of a certain percent drawdown.

Click to enlarge

With new highs comes excitement and yes, complacency. Regardless of desire, the market will always surprise, both on the upside and downside. With investors continually buying stocks and pushing multiples higher and higher as slowing expansion of corporate profit margin growth continues, the danger is the tug-of-war. Which side is going to give?

Over the past decade, the S&P 500 has produced an average 7% annual "top-line" growth (revenue). Last year, it was just over 4%; this year, considering the current earnings thus far, it would be lucky to produce over 2%. My firm's second quarter report, out last week, pontificated on this subject and the numerous factors contributing to the "financial engineering" happening in corporate America, i.e. continually growing earnings with less and less revenue to support expanding multiples. Hence, the answer to this tug-of-war may come sooner than we think.

Typically when the market surpasses an important pivot high, such as the "taper day," there is technical clarity that arises within a week or two. This will come in the form of a small consolidation and continuation of trend or a retracement back down toward the last bottom (June 24). Regardless, the short-term risk is currently (assuming no black swan event) the 7.5% recent gain. If a retracement of this nature was to occur, it would set precedence for further consolidation and volatility. It would also send quite a shot across the bow for most technicians as this would indicate a potential "double top" in the market.

With earnings season more than half over, the market will begin to seek other means of carrying forward. For now, our outlook is the same. Be cautious and mindful, but stick with the current trend.

I hope this helps and finds you well.

Editor's Note: Read more at Tesseract Asset Management.

Twitter: @TAM_News
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No positions in stocks mentioned.

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