TAG | Market trend
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Why This Market Truism Just Isn’t True
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Why This Market Truism Just Isn’t True
by Alexander Green, Investment U Chief Investment Strategist
Monday, December 5, 2011: Issue #1657
In my first book, The Gone Fishin’ Portfolio, I made a confession that startled some readers…
I retired from the investment services industry while I was still in my early 40s, but many of my clients had not become financially independent. This was not because I advised them poorly. I dealt with my clients honestly and gave them the best advice and service I could.
Yet, in many ways, they operated at a disadvantage. Some had a poor understanding of investment fundamentals. Others found it impossible to commit to a long-term investment plan. Many were simply too emotional about the markets, running to cash at the first hint of danger.
Contrarian instincts are rare, too, I learned. Few people are emotionally stirred by low stock prices. But every time there was a correction, a crash, or financial panic, my Scottish blood would surge, my pulse would rise, I’d rub my hands together, and start buying.
My clients, on the other hand, often did just the opposite, sometimes because they were too nervous but often because they bought into the old chestnut that a good investor doesn’t buy into a market downturn.
“The trend is your friend,” they’d say. Or “Don’t try to catch a falling knife.” This is surely the conventional wisdom in some quarters, but it’s not particularly wise. Here’s why …
For the last several months, traders have obsessed over problems in the Eurozone and the strength (or perceived weakness) of the U.S. economy. Taking a decidedly downbeat view, the market had a pretty horrendous November. But sentiment can turn on a dime and stocks can put on a furious – and completely unexpected – rally.
If you don’t already own stocks, it’s tough to catch the train after it has left the station.
Yet many gurus, including growth-stock advocate William O’Neill and his widely read publication Investor’s Business Daily, often insist that you shouldn’t but a stock unless the market itself is in a confirmed uptrend.
That may make sense in theory, but it often fails in practice. For instance, on page one each day, that paper reports whether the market is in a confirmed uptrend or downtrend. (And sometimes hedges, using language such as “Uptrend Under Pressure.”)
As we all know, this has been a volatile year for the market with the major indices bouncing up and down repeatedly. But you could hardly have chosen a worse strategy than to wait until the market was in a confirmed uptrend before buying. All that meant was that you bought into every short-term spike and then hit your trailing stops over and over again. (It must feel like banging your head against the wall.)
The Oxford Club has hit a number of its stops this year, too, sometimes protecting profits, other times protecting principal. But by buying great companies when the market was under pressure, we ended up with a lot of attractive entry points and plenty of both realized and unrealized profits.
True, if stocks go into a secular bear market, you can end with losses no matter how well you timed your entry points. However, you can never know whether a market drop is merely a correction or something more ominous until you are looking in the rear-view mirror.
You have to stick your neck out occasionally, pick your spots and buy stocks. If you don’t, what are you going to do? Buy bonds yielding 2.5 percent? Hold a money market paying less than one-tenth of one percent? It’s tough to beat inflation or meet your financial goals that way.
Let me make one thing clear, however. It’s most definitely a mistake to buy a troubled company that’s in a downtrend, no matter which way the broad market is heading. (That only works for those with exceptionally long time horizons – and often not even then.) But buying great companies when the broad market is a downtrend gives you a chance to obtain good prices on fine long-term investments and take advantage of tradable short-term rallies, too.
The next two months are traditionally one of the strongest periods for the stock market. No one can say, of course, whether that tradition will hold. But it’s a reasonable strategy to buy great companies when the market is down.
If your goal is to sell high, you have to start by buying low. And market corrections – like the one we’ve seen lately – give you an excellent opportunity to do just that.
Good investing,
Alexander Green
7
Investing in Stocks: Ignore the Negatives, Embrace Your Contrarian Side and Buy Stocks Now
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Investing in Stocks: Ignore the Negatives, Embrace Your Contrarian Side and Buy Stocks Now
by Alexander Green, Investment U’s Chief Investment Strategist
Tuesday, September 7, 2010: Issue #1338
When the Dow bottomed near 6,500 in the thick of last year’s financial crisis, few investors thought it was a good time to buy stocks. Sentiment was overwhelmingly bearish.
So when the market bounced higher, the consensus was that it was a “dead-cat bounce,” a bear-market trap. But it wasn’t.
As the rally gained speed, investors began to think that perhaps the worst of the financial crisis was indeed over and they would buy some stocks on a retracement or when the market tested its lows.
But that didn’t happen either. In fact, the Dow didn’t tire until it crossed 11,000 in May. By then, the market was up over 70% in just 14 months.
That was pretty depressing to investors sitting on the sidelines, earning microscopic yields on their cash. Many were so busy licking their wounds from the sell-off that they made little or no new investments during the rebound.
So what should you do now?
Investing in Stocks: Follow the Earnings
Since the market high four months ago, the Dow has lurched back and forth. But the primary direction has been down. No surprise here. After a rally of this magnitude, a correction is not unusual.
But don’t be like last year’s investors and miss the next rally. Now is a good time to put money to work in high-quality stocks.
In fact, the market is almost as cheap today as it was during the depths of despair in March 2009.
How is that possible when the Dow is more than 3,500 points higher?
Because a stock or index price doesn’t tell you anything about valuation. What matters are earnings and the multiple that the market puts on them.
Three Reasons Why You Should Buy Stocks Today
When measured by profits, the market is almost as cheap today – at 14.9 times trailing earnings and 12.2 times prospective earnings – as it was in March last year.
That’s because earnings are up. Way up. Second quarter profits at U.S. companies hit an all-time record.
A year and a half ago – when investors should have been buying stocks – the media was busy telling them about The Great Recession and how the world was coming apart at the seams.
Today, it provides saturation coverage of home foreclosures, personal bankruptcies and endless political carping. And because we’re blanketed with bad news, few investors see the positives. Consider, for example:
- The Fed has taken interest rates to near zero. That makes it cheaper for consumers and businesses to borrow. It also makes ultra-low-yielding cash a horrible investment.
- Inflation – the great bane of both stock and bond investors – is M.I.A. With the consumer price index showing virtually no increase, businesses don’t have to battle rising costs.
- Around the globe, most stocks are unloved and undervalued. Historically, when the P/E of the S&P 500 has dropped dramatically – as it has since the highs of May – it isn’t long before the market puts on a significant rally.
A Leaner Corporate America Could Drive the Next Rally
I know analysts are saying that earnings won’t be anything great. But they could be wrong – yet again – for two key reasons.
- Businesses have tightened up their cost structure, laid off unnecessary personnel and refinanced debt at lower levels. Even a modest uptick in sales could deliver surprisingly good bottom-line growth.
- It’s so cheap for businesses to borrow right now that I expect we’ll see many of them issuing debt to buy back their own shares. This could lead to robust growth in earnings per share, even if growth in gross earnings is less dramatic.
The bottom line?
Investing in Stocks: The Ultimate Contrarian Indicator Right Now
Stocks today are almost as cheap as they were when the Dow hit 6,500 18 months ago. And the macro-economic picture – while always cloudy – is a heck of a lot better now than it was then.
As an investor, look at your options. Cash pays next to nothing. Treasuries yield little more and could easily drop precipitously. Real estate is a non-starter, due to illiquidity, a flood of foreclosures and tough new lending rules.
But stocks offer excellent potential. And if you know anything about contrarian indicators, the fact that so few believe it only confirms it.
Good investing,
Alexander Green
