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It’s Time to Go ‘Risk Off’

For the record: I personally believe that market timing is folly, that “cash is a drug” and that people must always guard against their biological urge to buy high and sell low.

Also for the record: I believe we are in the midst of a sustainable rally and that stocks are the place to be for the long-term — because hints that the bear market is at an end, because the “great rotation” into stocks seems not be a question of “if” but a question of “when,” and because there are simply no good alternatives to equities right now.

All that said … stocks are in for a bumpy ride in the near-term. So it might be time to keep your powder dry if you’re a long-term investor looking for new moves, and to go “risk off” with your portfolio if you’re a short-term trader.

Here’s why:

Insiders Are Bearish: Corporate insiders are selling stock at the fastest clip since late July 2011, according to some reports. The S&P 500 crashed 15% in a matter of weeks soon after that point — and it took the index about seven months to claw back those losses before moving higher. Sure, insiders might just be trying to take a little bit of profit while their company stock is at multiyear highs … but it could be more than that.

Valuations Are High: And whether you’re an insider or not, it’s worth looking at your own portfolio and considering how your stocks are valued vs. historical norms. The S&P 500 has a trailing 12-month price-to-earnings ratio of 17.9 as of this writing vs. 15.1 a year ago; the Nasdaq-100 has a P/E of 16.6 vs. 11.1 a year ago; the Dow Industrials have a P/E of 15.4 vs. 14.4 a year ago. These figures are high not only compared to recent valuations, but also to historical norms.

Stocks Are Too Fashionable: The record flow of more than $77 billion to equity mutual funds and ETFs in January should be cause for concern. It’s good to see retail investors getting back in the game, but one should always be skeptical of the running of the herd because it frequently prefaces a move the other way.

Even Bulls Expect a Break: If you are one of those bears who refuses to capitulate, that’s one thing. But even bulls admit that after a great (but choppy) run of 25% for the S&P across 18 months, it might be time to take a breather and let the data and valuations come back to reality. Lance Roberts of Street Talk Live has a great group of charts on this topic, looking at stocks vs. GDP and earnings and more — and all hint that we are due for the “next major stock market correction (that) will likely be the last for this cycle.”

Overbought Across the Board: Aside from technology — which has seen some laggards lately including Apple (NASDAQ:AAPL) and Microsoft (NASDAQ:MSFT), to name a couple — data from Bespoke Investment Group shows every other sector of the market looks overbought in regards to deviation from 50-day moving averages. This is not a sure-fire sign of a crash because prices could keep trending up and resolve the moving average dilemma over time … but the alternative is for prices to correct. And as Bespoke puts it, the overbought nature of stocks mean that “it has a long way to fall before even sniffing oversold levels” should a correction start.

Earnings (or Lack Thereof): According to FactSet, the S&P’s blended profit growth (reflecting both current earnings and upcoming forecasts) is just 4% for Q4 2012. Sure, that’s better than a contraction in Q3 … but it’s the second-lowest growth rate in three years, behind only the lackluster period that preceded it. Call me old-fashioned, but I get nervous when profits are flat-lining but the market continually pushes higher.

War and Oil: It’s impossible to do anything other than speculate wildly about the geopolitical risks of the Middle East, but any informed observer should admit that there is the possibility of big economic and energy disruption if any number of things go south in the region. From Egypt to Syria to Mali to the constant saber-rattling in Iran, there’s a lot at play here. Oil is already hovering around the $100 mark, and with the Middle East and North Africa accounting for about 40% of global petroleum output in 2012, it won’t take much to send energy prices much higher — negatively impacting consumers and businesses.

State of the Union Tensions: The bears love to hate on federal spending, Washington politics and often President Obama in particular. There’s a persistent fear that we are only one soundbite away from a gap down — with one Raymond James strategist predicting a 5% to 7% move down, according to Business Insider.

Sequester Shenanigans: The fiscal cliff actually was quite a nonevent, since Republicans lacked leverage and had to strike a modest deal on taxes to prevent automatic increases that were much worse. Same with the debt ceiling, which was resolved quickly and painlessly. However, the March 1 sequestration deadline is much different. After caving in twice in a row, the GOP will feel the need to make a stand — perhaps even allowing $1.2 trillion in automatic spending cuts to take place just to prove they have backbone. That could severely restrict economic growth as well as rattle markets.

This is not to say I advocate going to cash and hiding in a bunker, or that I think there aren’t some decent values right now for long-term investors. However, it’s worth noting the short-term downtrend even if you’re not a swing trader because you might want to draw down any positions you’re thinking of selling sooner rather than later … and keep that cash at the ready for the dip when it comes.

Related Reading

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP.

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