A column of Jim Lowell’s on Marketwatch was entitled “Beach Blanket Bingo” - suggesting that investors could perk up the summer doldrums with foreign small-cap companies (actually, ETFs). I don’t mean to pick on Lowell, but in the decaying stages of a bull market, which is where the market now is, it is the large caps that perform best. A number of financial writers suggest that the place to be now is with blue chips, and I concur absolutely. Here’s why…

The trajectory of a bull market looks like this: small stocks ignite bull markets, then the mediums come in, and the large caps take off latest of all. In fact, when large caps ignite and start performing well, the smaller- and medium-cap stocks are not doing so well typically, a result of the flight-to-quality syndrome. This was best illustrated in the March 2007 correction, in which the blue chips fared best and recovered the fastest (if they even took a hit at all), precisely because of the flight out of smaller- and medium-sized companies into large caps - in other words, quality. When we start reading in the financial press that blue chips are outperforming all the sassy young companies, it is clear that the end of the bull market is in sight. Perhaps not imminent, but in sight. This behavior is not a bad thing, merely a sign of the end times for a bull market, make no mistake.

Lowell is definitely out of step with other financial writers at this point. Michael Kahn, for instance, suggests that the dollar is rising as a result of - not causing - mounting danger in the financial markets, and the cure is to stick with blue chips. Doug Sander of Wachovia: stocks will move higher in coming months due to growth in large-caps. Brian Belski of M. Lynch is promoting large-cap healthcare and consumer staples, which though lacking “exciting numbers” are nonetheless “strong and consistent growers” - they are necessities and not linked to employment and economic trends.

Now, there’s a glowing endorsement of a bull market, if you’ll excuse my sarcasm. It actually is good advice, though: stick with companies that in coming times might actually make money, even if not a whole lot. Kingman Penniman of KDP Investment Advisors says investors may have to refocus now on earnings and revenue. Well, THAT’s a sure sign of an exploding bull market, hmmm? Wrong. We’re hearing this same refrain everywhere: things are a little shaky and uncertain, so move to quality. Partly because quality is where the RETURNS are, but as much or more so because that is where SAFETY is. While no stock is ever truly “safe,” relatively speaking, the blue-chippers are “safer” now.

OK, you covered call writers, forget the beach blanket bingo and heed the smoke signals. The safest stocks to be in now are the large caps that are growing earnings or at least maintaining healthy profitability. In healthcare, be cautious of pharmaceuticals and stick with the largest and most profitable of them if you write the pharmas.

Stocks are down now as the market corrects. August is normally a dull month, but by late August we should see a rebound in the market, if indeed this sell-off is only a correction. If you had calls written on stocks that are down now, this could be a great time to buy back those calls to clear the decks. Be careful about writing stocks at a lower strike that are down now, since you may be trapped in that too-low call strike if they rebound with the market.

Those of you who bought protective puts at a higher level: it is not time yet to sell the puts, since the market seems disinclined to hang onto the 13,200 level - support in the June pullback was 13,251. Wait to sell the puts until we have a decisive bottom and recovery.

This entry was posted on Wednesday, August 1st, 2007 at 12:59 pm and is filed under Covered Calls, Markets/Economy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.