Investors who capitalized on the market's amazing six-month run are now going to want to find a way to protect their profits as a potential correction looms.
Bulls and bears are in a pitched battle over which way the market may run, with some awaiting a seemingly inevitable pullback that has shown only a faint shadow, while others believe the market has more room to grow yet.
The answer, though, may lie somewhere in between, and investment advisors are contemplating a full menu of options on how to proceed for the final quarter of a whipsaw year on Wall Street.
"The coin is in the air," Art Cashin, director of floor operations for UBS, told CNBC. "We don't know where it's going to quite go yet."
While no one is flocking for the exits, investors are trying to find ways to hold onto the gains they realized from the massive rally off the March lows.
Many advisors are telling clients to take at least some of their profits off the table, but that doesn't mean they still won't be looking for returns.
"Fourth quarter 2009 is no time to be a hero," says Lawrence Creatura, portfolio manager and equity market strategist at Federated Clover Capital Advisors in Rochester, N.Y. "However, it is important that you do not leave yourself underexposed to economic improvement."
Here are seven ideas likely to be popular in the next three months:
1. Emerging and Other Foreign Markets
If there's one universal profit-protecting theme among portfolio managers heading into the fourth quarter, it's the need to move out of solely US-based interests and develop exposure to foreign markets.
"Be very quick to be conservative. Move more to something that's going to protect your gains," says Rodney Johnson, portfolio manager at the Dent Tactical exchange traded fund , which launched in September and seeks to capitalize on global trends. "Move to international markets. Just be cognizant that the market moves up quickly and can move down fast."
Indonesia, Korea, Turkey, Russia and Brazil were among the big foreign market winners in the third quarter, while Japan, China and Israel lagged.
Investors are expecting a bounceback in China, and in fact see the rest of the world's economies collectively outpacing growth in the US.
"The momentum trade of continued growth overseas will occur for a little while longer, or longer than the US," says Blair Anderson, managing director of HighTower Investors in Chicago. "We've had a stimulus up-move in the markets in the US and it's somewhat over the reaction. It's not over in China."
After a year of yo-yo trading in 2008 and the early part of 2009, oil has settled into a fairly tight range. But there are still opportunities in the energy sector, which is likely to be closely watched in the fourth quarter.
"We still have large exposure to energy and are overweighted energy stocks in our portfolio," says Ben Halliburton, managing director of Tradition Capital Management in Summit, N.J. "We're not being aggressive on the buy side right now but we think there are some good upsides in various stocks."
He thinks crude prices will stay low in the near term but could go significantly higher when supply becomes an issue again. For now, he's advocating a few specific plays.
Among the favorites Halliburton cites are Conoco Phillips and Transocean.
3. Stock Picking
Indeed, most market pros now are cautioning against playing the entire market, advising instead to carefully select stocks within specific sectors that are poised for growth.
"The macro market of last year has shown signs of giving way to an environment where stock picking could contribute more to performance," BofA-Merrill Lynch analyst Savita Subramanian wrote in a note to clients. "Company performance is growing more differentiated, and continued high levels of uncertainty suggest a less efficient market, where stock selection could provide a greater advantage."
In a dicey environment, being selective is critical for investors looking to protect profits, Creatura says.
"The environment that we're in is very dynamic and there's a lot of uncertainty and fear," he says. "You can have some success in finding names that will drive alpha, names that will drive performance."
4. Get Defensive
Similarly, portfolio managers are heading to names that traditionally provide security while the market looks for further direction.
In one respect that's a good trend, in that it indicates market behavior is starting to return to normal and is past armageddon-type scenarios.
"We've gone in varying degrees through these periods where the volatility spikes, and I think for the most part we're pretty much over that," says Michael Cohn, chief investment strategist at Atlantis Asset Management in New York. "We can get back to a much more normal environment in general. As a money manager you can breathe a sigh of relief. You don't have to be scared to death constantly."
As part of his strategy Cohn is turning to familiar names like Procter & Gamble and Johnson & Johnson. He has 5 percent allocated to a managed commodities fund and also thinks biotech could outperform as the country continues with its health care debate.
Another fairly defensive play, the profile of the gold investor has changed somewhat since the metal has eclipsed $1,000, though the benchmark has served as a bit of a resistance level.
"Gold used to be looked at as a way to hedge inflation. Now it is trading from a perspective of safety" against an economic downturn, Anderson says.
Gold prices have risen along with the stock market and economic indicators, indicating investors want some downside protection should the rally fade.
Forecasters have been predicting a gold rise to $1,200 an ounceand few expect the run to fade anytime soon. Gold and other commodities benefit when the dollar is weak, a situation unlikely to change anytime soon.
6. Home Builders
If there's an area of the market that seems to be encouraging risk, it's housing.
Home builders are at the top of the class in this group, with strong sentiment lately that the group is poised to go higher. Goldman Sachs recently raised its outlook on the group, and New York broker Oscar Gruss recently opined "it's time to go long the homebuilders," initiating coverage on D.R. Horton and KB Home with "buy" ratings on each.
While there have been a slew of factors cited—leveling in prices, low mortgage rates, government intervention—Creatura says it comes down to supply.
"There are a lot of industries where capacity utilization is low but the entire productive base has been reduced," he says. "As demand rebounds there's less capacity available to service that demand."
In addition to builders, the capacity utilization criteria fits the insurance, retail and air freight industries, he says.
There's less universal agreement on the strength of tech, which has helped drive the rally. Consumer electronics was the 11th strongest sector in the third quarter, growing 44 percent, and some think the move higher can continue.
BofA-Merrill Lynch cited the group's strong valuation, consolidation and cash as reasons it could move higher.
On the downside, the group has some of the market's most attractive names and could thus be somewhat oversold.
"There's been window-dressing in portfolios from money managers towards September. They're not going to print their portfolios without showing they own Apple , Google , Yahoo and the other big movers," Anderson says. "Now that we're past the third quarter money managers are going to want to reduce their exposure."
The sentiment reflects a general uncertainty about the market that will present challenges for investors through the duration of 2009.
"We are very concerned that the market, while priced for a V-shaped recovery, is set up for some significant disappointments," Halliburton says. "We think a V-shaped recovery is very unlikely and the probable scenario is for a continued modest correction."