Biting the Apple

If you need evidence of why it's not good investing strategy to ignore a shift in market sentiment just because you think it is fundamentally wrong, take a look at what has happened to Apple (AAPL) shares over the past three months -- and more specifically in the days since the company announced earnings for the first quarter of fiscal 2013.

I see no fundamental evidence that growth is over for Apple, that the company is about to suffer massive erosion of market share, that Apple can no longer innovate or that margins are about to collapse. I simply don't see that story, but that story has nonetheless driven the 38% drop in the stock from its high to the Jan. 25 low. I see the carnage as a result of fear that there was no one left to buy Apple shares, a desire by analysts to avoid the blame that adhered to them in 2000 when Internet highfliers collapsed, and -- mostly -- a sense that Apple had to fall because it had climbed so high.

In other words, we scared ourselves.

But that doesn't mean Apple's loss is any less real -- the dollars are still dollars. And it doesn't mean sentiment can simply be ignored. (Try telling your broker that the Apple shares you want to sell are actually worth $660 on the fundamentals and that your brokerage statement should credit them to you at that price.)

Sentiment counts. Losses from sentiment count -- even if you're convinced that the drop is just because our good fortune has scared us into selling.

So what do you do about the possibility that at 1,500 on the S&P 500 we're going to scare ourselves into a market retreat, simply because the market has climbed to 1,500?

Fighting the fear

Start by covering the basics.

Make sure you know what you think the stuff you own is worth, based on the longer-term fundamentals. That will make it less likely that you'll get caught up in panic selling if sentiment moves against you. Part of this exercise is also to see if you've been caught up in sentiment on the upside and are holding stocks at prices you can't justify.

Do some risk/reward analysis. Markets (and individual stocks) do get overbought. That doesn't mean they're about to plunge. Most overbought markets don't plunge on the day they get overbought. Instead, they proceed to get more overbought.

But just because a market doesn't plunge when it becomes overbought doesn't mean the risk isn't rising. Fortunately, when an individual stock, sector or country market is becoming overbought and more risky, there's usually something else out there that offers similar potential with less risk. And I find that taking some profits and reducing risk is easier to do (and frequently more profitable) if I've got an alternative destination for my money. (In my experience, trying to sit out a rising market in cash is extremely difficult. One frequent pattern -- and I've been here -- is wisely moving to cash, but on the early side, then discovering that you can't stand sitting on the sidelines as the market rally continues. At some point -- and frequently, this point is painfully close to the actual market turn -- you can't take the pain anymore and jump back into the market just in time to catch the downturn.)

For example, if you think an individual stock or the entire housing sector in the United States is scarily high, think about taking profits in a homebuilder such as PulteGroup (PHM), up 178% in the past 12 months, and putting the money into Rayonier (RYN), up 22% with a 3.21% dividend yield. There have been signs that some homebuilders are running into constraints on sales, created by low inventories of land. That might make a shift to a land-rich real-estate investment trust such as Rayonier a profitable and risk-reducing move.

If you think the entire U.S. market is heading toward overbought, then maybe you look at individual stocks where future appreciation is likely to be driven by factors internal to the stocks. Names that fit that description include MGM Resorts International (MGM), where the drivers are debt reduction and progress on the company's new casino on Macau's Cotai Strip, and Cheniere Energy (LNG), where the driver is progress on construction of the first liquid natural gas terminal approved to export natural gas from the United States.

Or if you find 1,500 on the S&P 500 scary-high, then maybe you take some profits on U.S. stocks and put the money into Japanese and Chinese equities. Japan's stock market is a relatively low-risk bet over the next month or two on a big asset-buying program from the Bank of Japan that will drive down the yen. Japanese exporters such as Toyota Motor (TM) or Ricoh (RICOY) -- which is offered as 7752.JP in Tokyo -- have huge leverage to a cheaper yen. China's Hong Kong and Shanghai markets still have a long way to run before they start scaring investors with five-year or all-time highs. The Shanghai market, for example, was close to a four-year low as recently as December. At this early stage, financials and securities stocks such as Ping An Insurance (PNGAY) and Citic Securities (6030.HK in Hong Kong) come with more upside potential and less risk of a market top in sentiment.

I think any pullback in the U.S. market caused by investors scaring themselves is likely to be relatively shallow and brief. I think there's significant money in cash or in bonds that would welcome a chance to buy into equities at a lower price.

But I'm fully aware that in saying that, I'm trying to judge sentiment among my fellow investors and to predict how investors will react to any market retreat. That's the shaky ground of supposition indeed.

Updates to Jubak's Picks

These recent blog posts contain updates to the stocks in Jubak's market-beating portfolios:

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At the time of publication, Jim Jubak did not own or control shares of any company mentioned in this column in his personal portfolio. The mutual fund he manages, Jubak Global Equity Fund(JUBAX), may or may not now own positions in any stock mentioned in this column. The fund did own shares of Apple, Cheniere Energy, MGM Resorts International, Ping An Insurance and PulteGroup as of the end of September. Find a full list of the stocks in the fund as of the end of September on the Jubak Asset Management website.

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Jim Jubak's column has run on MSN Money since 1997. He is the author of the book "The Jubak Picks," based on his market- beating Jubak's Picks portfolio, the writer of the Jubak's Picks blog and the senior markets editor at MoneyShow.com. Click here to find Jubak's most recent articles, blog posts and stock picks. Get a free 60-day trial subscription to his premium investment letter JAM by using this code: MSN60 when you register here.

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