Selling stocks at DJIA 9780.

If and when the DJIA hits 9780 I am going to start selling equities on a fairly large scale. If the DJIA does not hit 9780 by September 6, I will sell equities anyway.

My current portfolio composition is 60% equities and 40% fixed income. I plan to rebalance to about 30% equities and 70% fixed income.

Am I predicting a turning point at 9780, or an end to the summer rally?

Not really. I do think the market will fall back quite a bit sometime in the fall, but it is difficult to pick market turning points and I am not all that confident about that forecast.

Instead, feeling that the market has had quite a run and because I rebalanced into equities in November of 2008 (below 8000) and March 2009 (below 7000) I am locking in profits, which are considerable, from those purchases. (Most of the funds involved are in retirement accounts, so there are no tax consequences).

I really don’t care if there is a turning point. If I am wrong and there is no decline, my 30% equity stake will still allow modest gains. If I am right and there is a decline, my 70% stake in fixed income will allow me to rebalance right back into equities after the decline.

Meanwhile I’ll sleep better with a 30/70 portfolio.

The fixed income part of my portfolio currently consists entirely of U.S. Treasury mutual funds, including some TIPs and money market bills, but includes nothing with a maturity of greater than 5 five years (except for the TIPs). I do think interest rates will rise and might rise sharply and with little warning, which would provoke sizeable capital losses in longer-term Treasuries.

I think the market will turn down for a lot of reasons:

1. The earnings growth implied by the recent market rally are simply not there and won’t be there any time soon. Although businesses have succeeded at cutting costs, stabilizing their earnings somewhat, consumer demand will be tepid for years to come. It’s partly the wealth effect – consumer perceptions of their own wealth has plunged because of the destruction of home equity and investment account values. High levels of debt continue to be a problem. A very high percentage of U.S. households are in serious financial trouble. Job losses continue and employment will not stabilize for months.

2. Rallys from large market drops usually have setbacks at some point. For example, in the dot com crash, between January 14, 2000 and September 20, 2001 (an interval that included the 911 attacks), the DJIA declined from 11,723 to 8,236 (see the graph). Then there was a strong rally until the next March 12, a period of about six months, that lifted the DJIA 30% to 10,633. Then the real collapse happened, pulling the market down over the next nine months to its low of 7,423. History doesn’t always repeat itself, but for larger cycles, most of the early recoveries have relapses.

3. I have warned in my classes that the kind of volatility that we have witnessed in commodities, and not just oil, will be ubiquitous in all financial markets for years to come. It is easier than ever to speculate (witness the explosion of ETFs and ETNs including leveraged shorts and commodity ETFs and ETNs) and there is much more of it, and traders these days are myopic, fickle and suffer sentiment swings with a single Reuter’s release. High volatility implies momentum moves in both market directions, up and down.

So why 9780? It is not a magic number or a precise forecast. I simply must have a cardinal strategy to force myself to make a planned move. Otherwise I procrastinate or use the excuse of uncertainty to not take action. If 9780 gets here I’m selling, no matter what the immediate news or moment of excitement.

After all. I bought most of this stock when the DJIA was in the high sixes to high sevens, using a strategy in two steps exactly like this. So I will be taking nice profits and that is sufficient for me.