The three things that could end this bull market

The investment gods are a tough bunch. Just when you think you've nailed a winner, they shake you back to reality with a bump. And trying to nail tops and bottoms is very difficult to do - so much so that even the pros have trouble sometimes.

Take Elaine Garzarelli, for example, who accurately called the 1987 crash. Or Ralph Accampora, whose prediction that the Dow would reach 7,000 was considered laughable at the time. Despite calling these major events, they soon found themselves back on the wrong side of the fence for years.

Living in south Florida, I view the market in the same way as the hurricanes that sweep in every year. Just because the experts are calling for an active storm season doesn't mean I should close up shop and live in a dark, cave-like home for the next six months.

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The key is to prepare in advance, because after that it's too late. I ensure that I have food, water, batteries and other supplies to get through an emergency. But until there is more substantial evidence that a hurricane is coming, it's business as usual.

Right now, it's business as usual in the market, but the storm clouds are gathering...

Three 'froth factors' that could swing that market

Don't get carried away with the indexes blazing upward and setting new highs - this market is getting frothy. Here are a few reasons why...

Sub-Prime Mortgage Fallout: I suspect the sub-prime mortgage situation will come home to roost at some point. The Bear Stearns sub-prime-backed mortgage funds crisis may just be the tip of the iceberg. The firm just reported that, '... preliminary estimates show there is effectively no value left for the investors in the Enhanced Leverage Fund and very little value left for the investors in the High-Grade Structured Credit Strategies Fund as of June 30, 2007.'

The news shook the market and some fear that there could be other funds performing just as badly.

Housing Slump To Weigh On GDP Growth: On a related note, Fed chairman Ben Bernanke says the real estate downturn has slowed overall GDP growth in recent quarters and '... will likely continue to weigh on economic growth over coming quarters,' due to rising delinquencies foreclosures. The National Association of Homebuilders confidence index (which measures current sales and future sales) is now at a 16-year low, and the Fed just revised its 2007 GDP growth forecast down by 0.25% to a range between 2.25% and 2.5%.

Dollar Woes: The euro is trading at a record high versus the dollar ($1.38). The British pound is trading at a 26-year high at $2.04. The Canadian dollar has almost reached parity with its U.S. counterpart at $0.95. The Aussie dollar is at a 16-year high, and the New Zealand dollar has hit a 20-year high against the greenback. With inflation having a greater impact than in America, interest rates will likely rise further while the Fed sits still, so there could yet be more dollar downside.

Is this bye-bye bull market?

I suspect we're in the late stages of the bull market - the longest one since 1926. The Dow hasn't seen a correction of 10% or more in over four years and it's overdue.

A good sign of an end to a bull market is when the laggards participate. As you can see from the chart below, technology stocks, which have trailed the S&P 500, have recently begun to close the gap. That tells me that investors, desperate not to miss the party, are looking for anything that hasn't gone up significantly and are throwing their money into lower quality names.

So does that mean you should take profits and move into cash? Not yet. But you should tighten up your stops and keep a close eye on the market's moves to try and gauge a meaningful shift. People are expecting the pullback to occur at any time - it's inevitable. And I suspect it won't take much to move this market the other way. So I'm compiling a list of stocks I'd like to both short and buy at lower prices.

So if the top is near, why not just take profits now? The answer is because investors can move indexes and individual stocks much more than expected, meaning that trends can last longer and go further than you think.

I want to be sure to be able to take advantage of this version of the greater fool theory (which says that when markets and stocks rise to heady heights, you need a 'greater fool' to keep the rally going). I don't have to get out at the very top - I'm just content to let my winners run and start selling once I see solid evidence of a reversal.

As long as you use stops, that you adjust upwards as your stocks climb higher, you'll sleep well at night, knowing your profits are locked in and you'll still get to participate in additional upside. And when the storm hits, although it won't be pleasant, you'll be protected.

By Martin Denholm, Managing Editor, Mt. Vernon Research for the Smart Profits e-Report, www.smartprofitsreport.com

For more on how to keep your investments safe in these troubled times, read James Ferguson's recent cover story The tide is going out - is your portfolio protected? or Paul Hill's piece How to prepare for a market crash