Investors who are enjoying the current rally on Wall Street should be increasingly careful as the year ends and the new year begins, as one of the major reasons that the market is rallying is because money managers are buying stocks to keep their jobs.

In fact, the rally picked up steam in October as multiple meetings between money managers who missed the market's turn in July, took place inside of Wall Street firms, with the major topic being whether they should jump back into the stock market.

According to the Wall Street Journal: "The stock market's four-month rally, marked by 18 record closes in the Dow Jones Industrial Average since the start of October, isn't being driven primarily by bullish investors -- but by still-skeptical former bears who increasingly see no choice but to join in."

Indeed, fear rules at market bottoms, and at the end of the year, when jobs and bonuses are on the line, as "Hedge-fund managers, who can change course more quickly than their rule-bound mutual-fund counterparts, have been steadily reversing their bets on a downturn since the summer. That has increased the pressure on remaining holdouts as money managers' year-end performance figures loom and their fear of clients' wrath heightens."

Still, it is notable that Wall Street loves a bargain. So instead of rushing into overvalued technology stocks, it looks as if much of the money that was panicked out of cash, has gone into the beaten up housing sector.
Once again, against a crowd of boos, the Philadelphia Housing Sector Index (HGX) made a new high from its recent bottom on 12-6.

What makes the housing sector interesting, is that it is one of those areas of the market in which most of the stocks tend to rise and fall together, similar to the oil and oil service sectors.

As a result, investors can buy several stocks in the sector and expect a similar trend in most of them.

Our Fallen Angels portfolio, which specializes in oversold, undervalued, beaten up stocks that no one wants to own, but that offer significant upside potential, features at least five housing stocks at the moment.

One of them is Centex (NYSE: CTX). Centex is an interesting company, since it is a leading residential home builder, but also does a great deal of commercial work, offering the investor a slight bit of diversification when investing in the housing sector.

Centex has gained 32% since bottoming in July, and has recently crossed above its 200 day moving average, along with many others in the rest of the sector.

A look inside the company offers some startling data. The stock is trading at a P/E of 7, while delivering a 19% return on equity. This is a classic value buy.

What has made this stock one that only old timers and curmudgeons like us would get into is the fact that its earnings have plunged, due to the implosion of the housing market.

In other words, owning Centex, as owning most of the other housing stocks is risky, at this point in time.

If the Fed raises interest rates one more time, the rally in housing, and more than likely in the entire stock market will end.

Conclusion

So, here's the nightmare scenario.

Wall Street has been buying stocks since July, with the rally accelerating in October as money managers who missed the boat had to jump back in.

As the year comes to a close, if there is any doubt about the future, such as the war in Iraq getting even uglier, the Middle East situation getting even worse, the economy slowing further, or oil prices really moving higher again, the same money managers who had to buy stocks, will likely think about all the profits they made in the last three months.

In other words, this is a hedge fund driven rally, and it will likely be a rally that ends when hedge funds decide to pull the plug.

All it takes is a bunch of fellows and ladies in business suits to come to an agreement on whether their bonuses are big enough, for the rally in stocks to end.

Yes, we like the market's prospects for the next two to three years. And no, we haven't changed our minds about Dow 16,000.

But, we also know the way the world works. Thus, we thought we'd pass along a message of some caution to those of you who might be getting a little bit too giddy about all the gains that your portofolio might be making over the last few months.

© 2006 Joe Duarte, M.D.
Dr. Duarte's Bio and Archive

This analysis was originally posted on December 7, 2006 at www.joe-duarte.com

Special notice to Financial Sense News Hour listeners:
Joe-Duarte.com is having a special Double Offer subscription special this weekend, December 8, 9, and 10, 2006. To sign up:

1. Visit http://www.joe-duarte.com/free/order_choices.asp and
2. Write “Special Holiday Double Offer” in the Company Name slot on the order form.

Happy early holidays from Joe-Duarte.com