Stack on Stocks: Late-Stage Gains

02/25/2015 9:00 am EST

Focus: MARKETS

James Stack

President, Stack Financial Management

In all probability, we are in the later stages of this bull market, which is when surprising changes can occur quickly in monetary and technical indicators, explains Jim Stack, editor of InvesTech Market Analyst.

The boom headlines that first appeared last July are becoming more intense and more predominant on Wall Street. These kind of boom headlines typically precede or accompany a major top in the stock market.

Ironic as it may seem, the increasingly positive economic picture is a mixed blessing. Usually, only market historians and seasoned investors understand the implications of the recent boom headlines we've seen.

It’s one of the hardest lessons to learn and a difficult concept for investors to grasp, but optimism is always greatest prior to major market tops.

We’ll be perfectly blunt. Positive economic news is dangerous because it usually leads to imbalances that precipitate a bear market. The better it gets, the more prepared we have to be.

As we adjust our strategy for the months ahead, it’s important to note which sectors typically take the lead as a bull market ages.

Energy and Technology have historically been the late-stage leaders, exceeding S&P 500 gains the majority of the time.

In our model portfolio, we hold positions in Energy Select Sector SPDR (XLE) and Technology Select Sector SPDR (XLK).

Other defensive sectors near the top of this list—such as Healthcare and Consumer Staples—also have a higher probability of turning in gains at this stage of the market cycle.

As such, we also hold positions in Healthcare Select Sector SPDR (XLV) and Consumer Staples Select Sector SPDR (XLY).

We strongly believe that a bear market is looming and the current psychology and historical comparisons support this assessment. Yet, we know that market peaks take time to develop and are characteristically preceded by divergences in the technical and fundamental evidence.

Needless to say, this is not the time to chase momentum stocks or take excessive risks. Our carefully balanced defensive strategy is designed to take advantage of potential profits in this aging bull market, while also reducing risk as we watch for warning flags.

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