Wednesday, November 24, 2010
Is It Time To Buy Stocks?
When to Buy Stocks
Since October 2008’s dark days, investors have wondered when, or if, they should again invest in the stock market. The years 2009 and 2010 witnessed a massive repudiation of stock funds as investor sought the perceived safety of fixed income (bond) funds. $235 billion moved from stock mutual funds in 2008 and 2009. Seven months into 2010 $34 billion have followed that same path. Retail investors have turned their noses up at the risk associated with stock mutual funds (and with good reason- the majority of stock mutual funds are underperforming their benchmark, meaning investment results from buying an indexed ETF (Exchange Traded Fund) was greater (with much less risk) than paying for an active fund manager).
Institutional buyers and traders with their stock trading computers churning algorithms have brought the market back to levels that are starting to lure retail investors back into the “risk trade” or least provoke thought along those lines. Minuscule returns in the fixed income market are making many investors itchy to get back in the stock market. So how do you know when to make the move?
Here is a tried and true method for making the decision.
Rule number one- never try to time the market. If you feel like it is time to buy- that is the best indication it is time to sell and vice versa. When, and if, you decide to get back into the market, deploy a “dollar cost averaging” strategy. For example if you decide to put $100,000 back in the market do so at $10,000 per month. This takes out the emotional aspects of market timing and smooths out any unfortunate market swings. Only ignorant rookies violate rule number one and they end up paying for it.
Rule number two- done try to catch a falling knife. If the market is down and stocks look cheap some people will buy. Retail investors are more likely than not to fall into a what is known as a “value trap.” Judging that a stock is worth a price just because its price was higher just recently, is not a good way to value stocks. Let the professionals do that. Trying to pick a bottom in the stock market is a fool’s game. Wait on prices to show a steady increase. The risk associated with buying stocks in a rising market is exponentially less than picking winners amongst a bunch of losers.
Deciding to get back into equities means answering the fundamental question of whether or not an increase in the market’s value is foundational or just traders moving money around. A good rule of thumb is that the market reflects foundational value when the S&P 500 (forget about the Dow Jones Industrial Average) shows gains with three characteristics. First the volume is high on days when the market is up, secondly the rally is led by the financial sector and third the move is confirmed by an increase in the transportation sector shortly after the first two criteria have occurred.
Information to make these determinations is straight forward and available to anyone who can sign on the internet. Comparative volume figures in chart form can be found at Market Data. Just type “volume” in the sites search prompt.
To judge whether or not a rally (increase in S&P index) is being led by the financial sector go to Yahoo Finance. At the symbol prompt, enter XLF which is the symbol for the financial sector ETF. With a little effort one can use the new interactive charts on Yahoo to overlay the S&P index chart on the XLF chart. If the market is on a sustained uptrend and the XLF line is above the S&P line, its time to pay attention to what’s going on and start looking for conformation from criterion number three.
If the volume is high and the rally is being led by the financials it’s time to check the transports. The ETF for the Dow Jones transportation sector is IYT. Just go to Yahoo Finance and put “IYT” in the symbol prompt and the chart will come up just like a stock symbol.
If the market has a stable foundation on an upswing the financial sector will be leading the way (the XLF will have a greater gain in value than any other sector) with high volume. The confirming metric will be a slight uptick in the transportation sector.
This is a logical progression. Banks make good loans and start making money first. The markets recognize this and begin to buy broadly across the economy. Once the money loaned is put to use, the transportation sector revenue finally begins to increase. Sequence is important because a firm foundation is built in the stages I have described.
Right now NYSE market volume is low, everything is going up except the financials and the transports are flat. In other words, hold tight.
Market fluctuations in this environment can play havoc on an investors nerves. Low returns in fix income coupled with the losses suffered in 2008, fuel anxiety not to miss the next big move up in equities. Use these tools and they will protect you from your emotions. In this game emotional decisions equal losses.
Happy Thanksgiving to all of you and thank you so much for your support!