Is This Bull Market Over?

The market had a strong first quarter this year. The S&P 500 rallied 12% on the heels of an 11% gain in the fourth quarter of 2010. In fact, it has more than doubled from its bottom on March 9, 2009.

But lately the market has been wilting like last week’s roses, drooping in one session after another. Is the bull finally headed out to pasture?

Don’t count on it. While no one can forecast the short-term zigs and zags in the market, there are three good reasons to believe there’s still life in this bull:

1. History shows that pullbacks don’t generally follow a strong first quarter. The S&P 500 has soared 10% or more in the first quarter eight times since 1945. According to Standard & Poor’s, the market rose three-quarters of the time in the following quarter. And the one other time the market rose 10% or more in both the fourth and first quarters, stocks gained 5% the next quarter.
2. First quarter profits are likely to be another record. Don’t forget that corporate profits have hit all-time records in each of the last eight quarters. And – while the reporting season is just getting under way – this time isn’t likely to be any different. Yes, the gains will be more modest this time thanks in part to higher oil prices and tougher year-ago comparisons, but we’ll almost certainly see more all-time record profits for the first quarter and a few big surprises could send stocks higher again.
3. Investors are still afraid. That’s actually a good thing. As John Templeton declared, “Bull markets are born on pessimism, grow on skepticism, peak on optimism and die on euphoria.” You talk to anyone lately who’s euphoric about the economy and the stock market? Me neither. And people aren’t investing their money that way, either. According to The Investment Company Institute, investors yanked $1.2 billion out of stock funds in February after taking out $423 million in January. History shows a near perfect correlation between equity fund redemptions and stock market performance. It’s when investors starting throwing cash at the market that you need to worry. And we’re a long way from that.

When you look at the fundamentals, it’s surprising just how negative the average investor is. After all, we’re enjoying low interest rates, low inflation, expanding markets overseas (especially in the developing world) and all-time record corporate profits.

What’s keeping most investors at bay, of course, is volatility. And not just lately. Investors have been clobbered by two massive bear markets in 12 years. The 2000 to 2003 bear market took stocks down 49%. It was the worst market since the Great Depression – until the 2007-2009 bear market showed up. That ripped 57% from the leading market index.

Last year, the S&P 500 fell 3% or more six times, and on one gut-wrenching day in August, 6.7%. That made microscopic money market yields look attractive.

Of course, volatility is the price of admission in the stock market. If equity accounts rose as smoothly as bank accounts, everyone would be fully invested. But they’re not. Not even close.

Paradoxically, that’s another reason stocks actually look pretty good here.

Good Investing,

Alexander Green

Is it a Good Time to Invest in Stocks?

Is it a Good Time to Invest in Stocks?
by Alexander Green, Investment U Chief Investment Strategist
Monday, February 20, 2012: Issue #1712

More than two thousand years ago, the Greek sage and philosopher Epictetus counseled, “It is impossible for anyone to begin to learn what he thinks he already knows.”

Nowhere is this truer than in the stock market. You need only ask the many thousands of investors who have sat out an historic rally – the market has doubled from its lows years ago – because they just knew stock prices were only going to go lower.

That mindset has proved to be an expensive one. Yet these individuals now face another test.

If they jump into stocks today, having already missed one enormous move, they risk being in for the next leg down. That would hurt. On the other hand, if they continue to sit on the sidelines – earning next to nothing in bonds or cash – the market may well power higher and leave them with an even more extreme choice in the weeks and months ahead.

What is the prudent investor to do?

They Rise and They Fall

The first is to understand the error of your ways. Every market timer believes that if he sits patiently on the sidelines, he will get a better opportunity to buy stocks at lower prices.

And they often do. Unfortunately, they generally get to feeling so good about missing the downdraft that they convince themselves that the market will keep falling.

And, again, if often does. Until, of course, it doesn’t.

As the market climbs, they begin to rationalize that this is just “a bear market rally” or “a dead-cat bounce.” Until it becomes obvious that the train left the station and they’re still standing on the platform.

Cash is Not King, but Stocks Might Be

Warren Buffett’s mentor Benjamin Graham once said that no investor should have more than 75% of his money in stocks or less than 25%.

That’s a good rule of thumb. Seventy-five percent keeps you from getting overly enthused when times are good. And twenty-five percent keeps you from throwing in the towel when times are bad.

But what do you do now if you’re one of those who has played it too cautious until now and are fed up with your negative real returns in Treasury bonds or cash?

First, stop justifying what you’ve done and get off the dime. Start committing money to high-quality stocks in a gradual way. After all, if you shift a big percentage of your portfolio into stocks right now, you could regret it. And if you remain in cash, you could regret that, too.

So hedge yourself. Start moving money into stocks at regular intervals, being sure to keep buying if the market dips so you get better entry prices.

An Easy Way to Start Investing

A conservative place to start would be the Vanguard High Dividend Yield ETF (NYSE: VYM). True, it currently yields just 2.9%, but that’s still 50% more than 10-year Treasuries are paying and 50 times as much as the average money market fund.

Even if stocks go nowhere over the next 10 years – highly unlikely given the decade we just had – you’d still be better off in this fund than in a bond or money market fund.

There are a ton of reasons to put off making this move from the state of the economy to the size of the deficit. But that’s just the kind of thinking that got you stuck on the sidelines.

Look at the bright side. Inflation and interest rates are low. We’ve had five straight months of declines in the jobless rate. The ECB has extended three-year, low-cost loans to European banks. The Greek parliament has voted to actually cut spending. And we’re in a period of all-time record corporate profits.

So cast off. As the great nineteenth-century theologian William Shedd pointed out, “A ship in harbor is safe, but that is not what ships are built for.”

Good Investing,

Alexander Green

Does Low Volatility Put Your Portfolio At Risk?

Does Low Volatility Put Your Portfolio At Risk?

by Alexander Green, Investment U Chief Investment Strategist
Friday, January 27, 2012: Issue #1695

The stock market gyrated so wildly in 2011 that many investors finally threw in the towel.

How else can we read the massive equity fund redemptions that occurred in the second half of last year?

But, apparently, the market has taken its anti-anxiety medication. After last year’s gut-wrenching swings, U.S. stocks have been surprisingly tranquil. For 13 straight days, the Dow has moved up or down less than 100 points.

This is good news for bullish traders and bad news for those who have been making money trading the VIX. Let me explain…

The VIX is the ticker symbol for the CBOE Market Volatility Index, a popular measure of volatility in S&P 500 index options. According to The Wall Street Journal, this so-called “fear gauge” has fallen 20% to levels unseen in six months.

Why? One reason is that the U.S. economy appears to be getting back on its feet. Despite all the pessimism in the Eurozone, U.S. corporations are busy reporting yet another quarter of all-time record profits. (Just how long will mom-and-pop investors ignore this salient point?)

The Dow is up almost 500 points for the month. Fund companies report that money is flowing back into equities again. Yet the calm makes some investors nervous. I hear many analysts crying out that the market is about to plunge again.

Deluded, Ignorant, or Both

Let’s start with the straightforward declaration that anyone who claims to know “what the market is going to do next” is, by definition, someone who is ignorant, deluded, or both. The market will rise or fall next week or next month based on next week’s or next month’s news. Yesterday’s news has already been discounted. (As Legg Mason’s Bill Miller likes to say, “If it’s in the papers, in the price.)

Moreover, there’s no historical evidence to show that a market pause generally precedes a correction. And the data go back pretty far.

For example, market analyst Mark Hulbert has loaded the Dow’s daily returns – all the way back to its creation in 1896 – into his statistical software. For each trade date since, he calculated the Dow’s trailing volatility and then looked to see if the stock market performed any different following periods of low volatility than it did at all other times.

The short answer? Nope. He came up empty. Perhaps that’s the reason for the old Wall Street saw: “Never sell a dull market short.”

There are two things to conclude here:

• The hair-raising volatility that made trading (going long) the VIX like taking a tootsie roll from a toddler is over, at least for now…
• The other important takeaway is that traders and investors have no historical reason to believe that the recent pause portends a market downturn ahead.

Sure, a spike in oil prices, a hedge fund blow-up or a nasty surprise from across the pond could change that in a nanosecond. But bolts out of the blue are just one of the many short-term hazards of trading and investing.

For now, the market is taking a breather. But that doesn’t mean it isn’t about to get a second wind.

Good Investing,

Alexander Green

Why This Market Truism Just Isn’t True

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

Is It Different This Time?

Is It Different This Time?

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 22, 2011: Issue #1583

Investment legend John Templeton famously said that the biggest mistake an investor can make is to say “this time it’s different.”

In some ways, this statement may seem a little strange.  On the surface, every market correction is different. For example, when the stock market imploded on October 19, 1987, falling over 22 percent in a single session, that was unexpected. After all, no government failed that morning. No currency collapsed. No President was shot. To this day, pundits still argue about why the stock market crashed.

Or how about the bear market of 1990? No one foresaw Saddam Hussein rolling into Kuwait that August, taking over the country and its oil fields. Investors worldwide speculated that the Middle East would go up in flames. (And, indeed, many Kuwaiti oil fields did.) That was certainly different.

Then there was the collapse of hedge fund giant Long-Term Capital in 1998. Fed Chairman Alan Greenspan feared that unwinding the fund’s highly leveraged positions would turn the bond market upside down. He worked behind the scenes to get major Wall Street firms to help bail out the fund. That was something new.

Or how about the March 2000 to October 2002 bear market that started with the collapse of technology and Internet stocks? It was the end of an era, the deflating of a bubble. We hadn’t seen anything like that in modern history.

Or how about 9/11? Who woke up that day suspecting that a group of zealots would fly planes full of people into buildings? Not me.

The mania for residential real estate six years ago was something curious, too. And so was the collapse of sub-prime mortgages. That led to an unprecedented financial crisis and a harrowing drop in the Dow. You don’t see something like that every day.

So was Templeton out of his mind when he declared it foolish to say “this time it’s different?” Of course not. Templeton well understood that the particular events that cause a market decline will always vary. What shouldn’t vary is the way you respond to it as an investor.

If you bought into the market crash of 1987, you did very well over the next few years.  After the bear market of 1990, stocks went on a remarkable 10-year run. If you bought into the secular bear market of 2000 to 2002, you also made out handily over the next five years. And, of course, the market almost doubled from the lows of the financial crisis in 2009.

Here we are today and the stock market has swooned again, this time due to sovereign debt problems here and in Europe. Nothing like this has happened in recent history.

So the question you face now is whether to take advantage of the sell-off and buy great companies at bargain prices or… to insist “this time’s it’s different.”

The choice is yours.

Good investing,

Alexander Green

I Was Wrong About Gold and Internet Stocks and Real Estate

I Was Wrong About Gold and Internet Stocks and Real Estate

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 15, 2011

In the summer of 1999, I warned my friends that they were playing with fire, that the rip-snorting bull market in Internet and technology stocks was likely to end badly.

Most of them scoffed – and were glad they did. After all, Internet stocks weren’t anywhere near a peak in the summer of 1999. I was early. It would be nine long months before the scaffolding began to shake.

I never dreamed the mania could go for so long. But it did. And it taught me a valuable lesson. You can’t make a rational estimate of when irrational behavior will end.

The same thing happened with the housing bubble seven years ago. Almost no one was buying my skeptical take. I talked to realtors who had been in the business their whole lives and had never witnessed anything like the dramatic run-up in prices that was occurring. Yet most managed to convince themselves – and their clients – that prices would only keep rising.

Which they did. Until, of course, they didn’t.

Now we’re in the midst of a spectacular run in gold and silver. When I bump into typical investors at cocktail parties or backyard barbecues, they invariably tell me they are loading up on precious metals. “It’s a no-brainer,” a Merrill Lynch broker told me just last week.

I agree. I think some investors have left their brains with the hat-check girl. Here’s why …

• The price of gold and silver are now way above the marginal cost of production. When that happens, you get new supply. Yes, it takes time but, trust me – it’s coming. (High commodity prices always sow the seeds of their own destruction. Have you checked out agricultural prices lately?)

• Unlike oil, a depleting asset, all the gold ever mined is still around and is available to be sold.  If consumers rush to cash in on higher prices – or (ahem) falling prices – supply can quickly swamp demand.

• Higher inflation does not necessarily portend higher prices for precious metals. Gold hit $850 an ounce in January 1980. Although inflation hit 12.4 percent that year, the yellow metal was $300 an ounce lower in December. That was a 35-percent hit. And yet that was just the beginning of the end. Gold didn’t bottom out until almost 20 years later. Silver took an even more spectacular ride, hitting a high of $48 an ounce in 1980 and losing 90 percent of its value by 1982.

• Or take a look at gold equities.  While the price of the barbarous relic keeps rising, you’ll notice the gold stock index is no longer tagging along. Here’s the chart… Gold has pushed ahead over the last three months. But blue chip gold stocks have fallen, even though most of the big producers have removed their hedges. The smart money is betting that today’s high prices won’t be sustained.

• And how about the smartest money of all? Warren Buffett isn’t buying any nonsense about gold being “undervalued” at current levels. He openly scoffed at the idea in this April clip. And gold is only more expensive now.

Some readers might remind me (and should) that I was bearish on gold several months ago. Yet gold and silver have only pushed on to higher highs. Just as Internet stocks did. Just as residential real estate did. Just as tulip bulbs did.

Don’t get me wrong. Everyone should own some gold as a hedge against economic or political catastrophe. But if you are piling into gold and silver now – or if it makes up a quarter or more of your portfolio – you are truly living in Las Vegas.

I could be wrong, of course. Maybe gold and silver are still in the early stages of a tremendous run-up. But what if I’m not wrong? A 60 year old who jumped into gold in 1980 was down more than 60 percent on his 80^th birthday, if he lived that long. And that’s ignoring inflation, something gold bulls are not traditionally inclined to do.

The truth is no one can tell you where gold will be in a month or a year. Still, it wouldn’t hurt to heed the words of Mark Twain:

“History may not repeat itself. But it rhymes.”

Good investing,

Alexander Green

How Traders and Investors Should Play This Market

How Traders and Investors Should Play This Market

by Alexander Green, Investment U’s Chief Investment Strategist
Monday, August 8, 2011: Issue #1573

You often read in the financial press that stock market investors should do this or short-term traders should do that. But which one are you and what should you be doing now?

Here are my quick and dirty definitions, followed by a few thoughts about how each ought to approach today’s wild and wooly financial markets.

• An investor is someone set on achieving long-term financial goals: a comfortable retirement, the kids’ college education, or perhaps the down payment for a new house. Success here is measured in years, so this week’s market action is largely irrelevant except as it offers unusual opportunities. The important things to consider here are quality, diversification, asset allocation and keeping annual expenses and taxes to a minimum.

• A trader is someone who is trying to beat the market in the short term either to goose returns or reach short-term financial goals. This approach is inherently more risky, as the market action over the last few weeks has made crystal clear. The key here is to own great companies that are likely to post positive surprises in the short term (for example, great sales, high earnings, new product announcements, or an unexpected takeover bid). A trailing stop is essential to protect profits and limit any losses.

For the long-term stock investor, the current sell-off is almost certainly a gift from Fortune. I know, no one you know sees it that way, but look back through history. You’ll find that virtually every widespread market sell-off was a buying opportunity.

Yes, the market can go lower in the short term. (That’s always the case, incidentally.) But over the last 40 years, the S&P 500 has seen 25 corrections of 10 percent during a bull market. In only nine of them did the losses grow to 20 percent or more. Despite all the naysayers, a further sell-off is hardly assured.

One of the Few Reliable Rules of Investing

Still, you should only nibble at great stocks right now, not throw money at them in wild abandon. (Although I’ll bet that’s not your instinct right now, anyway.) One of the few reliable rules of investing is that perceived risk and actual risk are inversely related: The more dangerous the market feels, the more likely it is to produce generous returns in the years ahead.

So long-term investors gradually shift some money out of assets like bonds that have appreciated sharply and move them into stocks which have depreciated sharply. The fact that this feels like the wrong thing to do is, paradoxically, just the confirmation you need. (You need only recall the market meltdown two and a half years ago to see what I mean.)

Short-term traders need to take a slightly different approach, however. If you’ve been using our recommended trailing stops, you almost certainly have been building cash the last few weeks as you protected profits and preserved capital.

Don’t be in any rush to put this cash back to work. To take advantage of a crisis, you don’t have to be the first one to the fire. Pick your spots and trade judiciously. (One good strategy is to buy the same stocks that corporate insiders are currently loading up on.)

Don’t Risk Missing a Significant Rebound

Despite the stormy weather, you should cast a few lines right now. It may be tempting to simply wait until things “settle down” but then you run the risk of missing a significant rebound.

In short, tune out all the end-of-the-world hysteria and think rationally.

• As a long-term investor, shift money in cash and bonds into stocks.

• As a short-term trader – and you may well be both – scoop up great companies selling at unusual discounts – there are plenty of them out there – and adjust your stops to protect your gains.

You’ll thank me when things get back to normal. As they always do eventually.

Good investing,

Alexander Green