From October 2007 to March 2009, many got to experience firsthand the ‘for worse’ part of buy-and-hold investing. The Dow Jones (NYSEArca: DIA - News) lost 7.839 points or 54.90%.

Just before being snuffed out entirely, hope returned to Wall Street. Since the March lows, the Dow has rallied as much as 2.217 points. Patiently waiting for portfolios to recover all their losses has once again become a viable option.

Sobering facts

Despite the recent rally, which lifted the Dow by as much as 34.43% and the S&P 500 (NYSEArca: SPY - News) by as much as 28.31%, there is a long road ahead to reach the break-even point. Based on Dow 8,200, the stock market would have to rally another 72% just to reach October 2007 levels.

Even at an optimistic 12% annual return, it would take nearly five years for the broad market to recover to previous bull market levels. Chances are that the Financial Select Sector SPDRs (NYSEArca: XLF - News) won’t even come close to their high watermark within the next 10-20 years. This may sound absurd, but we’ve seen what happened to tech stocks after the dot.com bubble.

After briefly poking above 5,000 in March 2000, the Nasdaq (Nasdaq: QQQQ - News) hasn’t even come within 2,000 points of its all-time high. When the S&P and Dow reached all-time highs in 2007, the Nasdaq still traded 44% below its lofty 2000 high. The same is true for the Technology Select Sector SPDRs (NYSEArca: XLK - News).

Investors, who live in the past, cannot expect to reach their future goals. Yesterday’s losers hardly ever turn into tomorrow’s winners. It’s best to exit pockets of weakness before they turn into a bloodbath.

It’s almost been a year since the ETF Profit Strategy Newsletter strongly advised to shun financials and buy financial short ETFs such as the Short Financial ProShares (NYSEArca: SEF - News), and UltraShort Financial ProShares (NYSEArca: SKF - News). In a Trend Change Alert, e-mailed to subscribers on March 2nd, the newsletter recommended to close out short positions and buy long ETFs.

Such a pro-active approach has yielded double digit gains, while holding any of the major U.S. benchmark indexes for even just the past eight months has resulted in a loss of 20% or more.

Buy-and-hold - pros and cons

Breaking away from a long-term relationship can be painful and not without losses. Quality decisions can’t be rushed, so it makes sense to carefully weigh all the pros and cons.

Best case scenario, the stock market will continue to go up (we’ll talk about the market’s prospects in a moment). All boats rise with the tide, including the old buy-and-hold. If a portfolio hasn’t been rebalanced in a while, chances are it will actually underperform in an up-market. Here’s why:

High octane sectors, like the Consumer Discretionary (NYSEArca: XLY - News) and Industrial Select Sector SPDRs (NYSEArca: XLI - News), bounce higher and faster during an economic up-turn. Those sectors are also the ones that got crushed the most during the meltdown.

Due to recent heavy losses in high octane sectors, they are likely to be underweighted.  While conservative sectors, such as the Consumer Staples Select Sector SPDRs (NYSEArca: XLP - News) and Utility Select Sector SPDRs (NYSEArca: XLU - News), managed to gain an overweight advantage. This overweight in conservative sectors will cause a performance drag in an up market. At the very least, a face lift (rebalancing) would be required.

What happens if the market drops to new lows? As we’ve learned over the past 20 months, buy-and- hold portfolios do not fare better than the overall market. Losses are inevitable.

Pro-active approach - pros and cons

Obviously, the pro-active approach allows for direction to be changed more easily, just as a speed boat can adapt to a new course much faster than a super tanker.

A down trend can be neutralized, end even turned into a profit opportunity, by adding short or leveraged short ETFs such as the UltraShort S&P 500 ProShares (NYSEArca: SDS - News), or Short S&P 500 ProShares (NYSEArca: SH - News).

If the market decides to move up, extra returns can be squeezed out with leveraged ETFs, high octane sector ETFs, or dividend ETFs. Some dividend ETFs still come with double digit yields. On March 2nd, the ETF Profit Strategy recommended to buy ETFs such as the Ultra Financial ProShares (NYSEArca: UYG - News), a double leveraged financial ETF, the Vanguard Financial ETF (NYSEArca: VFH), and iShares Dow Jones Select Dividend ETF (NYSEArca: DVY - News).

The biggest danger of a pro-active approach is to get whipsawed - buying ETFs before prices fall and selling before prices rise. To prevent this truly unfortunate scenario, one has to keep an eye on the market.

There are different indicators that can be used to ascertain the market’s direction. Investor sentiment, volume, breadth, CBOE Put/Call ratio, and an array of other indicators can be used as a short-term compass.

P/E ratios, dividend yields, and the Dow measured in real money - gold - provide a reliable, big-picture, long-term outlook. None of the above indicators can solely provide an accurate forecast. However, compositely they can be a truly powerful beacon to navigate your portfolio through rough seas.

The ETF Profit Strategy Newsletter used a combination of short-term indicators to call a January market top above Dow 9,000, and a March bottom below 6,700. The March issue included a detailed analysis of the long-term indicators, along with the target range for an ultimate bottom and subsequent end of this rally.

This rally is giving investors a chance to sell unwanted stocks, ETFs, and funds at prices they would have signed off on just a few months ago. Procrastinators will be forced to make a tough decision at lower prices, while savvy investors will use the rally to their advantage. If you fail to prepare to prepare to fail.

This entry was posted on Tuesday, May 19th, 2009 at 2:45 pm and is filed under Uncategorized. 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.