When emotions drive the stock market — where does it go?
Just when things looked bleakest, the stock market turned around and started to rally. Where does that put us now, asks this U.S. advisory?
Cartoon: a guy is walking along Wall Street with a cellphone stuck to his ear. A heavily bearded panhandler is holding a sign that reads, “Work for Food.”
“Relax,” says the cellphone holder, glancing at the panhandler, “my broker says the economy will bounce back.”
“I am your broker!” says the panhandler.
The cartoon leads off the latest issue of The Primary Trend, which comes from an investment counselling service in Milwaukee, Wisconsin.
The cartoon is not meant to underline the hopelessness of the crisis we’ve been passing through, but the strangeness of it all.
Just when things were bound to get worse, they got better. Mr. Barry Arnold, head of the counselling service and editor of the advisory, tells us just why the market turned up when it ought to have turned down.
He also tells his readers why bonds can be less “safe” than stocks just when the opposite should be true.
But first, we’ll look briefly at a couple of stock recommendations he has made in light of the changes in the market.
Sensitive to the economy
In the last month or so, Mr. Arnold has been tilting toward stocks that are more sensitive to trends in the economy.
Thus, he has added Cisco Systems (NASDQ-CSCO) and FedEx Corp. (NYSE-FDX) to the advisory’s Undervalued Growth Portfolio. Cisco is a buy up to $20 (it trades at $18.50), and FedEx is a buy up to $60 (it trades at $52.83).
“Both are undervalued and should benefit greatly as global growth improves going forward,” he says.
The more stolid, recession-resistant Waste Management (NYSE-WMI) has been sold.
With this stock-buying shift in mind, let’s rewind to early March.
An art, not a science
After the markets had tumbled to depressingly low lows in March, a dramatic chain of events started to unfold.
Chrysler went bankrupt and General Motors followed close behind. Banks and many non-financial companies were “going to the tills to raise more capital.”
The U.S. dollar was losing its grip and yields on Treasury securities were jumping higher with the yield curve getting dramatically steeper.
“Combine this somber mood on Wall Street with the dark news on Main Street and where would one expect the stock market to be trading?”
Even farther down in the dumps, of course. But we know that is not what happened. Markets shot up to new recovery highs.
“This is counterintuitive,” admits Mr. Arnold, “but exactly why investing is an art, not a science. Emotions, especially at turning points, are a major driving force in bull and bear markets.”
The wall of worry
In fact, in times of crisis, markets often run in the opposite direction of the sentiment of investors. If this doesn’t seem to make sense, welcome to the wonderful world of investing.
Three months ago, the stock market was trading at 12-year lows “and the world was coming to an end,” says Mr. Arnold. Since, stocks have skyrocketed anywhere from 34 to 50 per cent, depending on the index you refer to, “and yet the dire news is still flowing.”
Yes, the market keeps correcting periodically, like an engine crying out for more maintenance. But what we’re watching is actually the norm, Mr. Arnold tells us.
“Some of the $4 trillion in cash on the sidelines has come back into the market; but most investors, both institutional and individual alike, are still wary ... still cautious ... still carrying ‘bear market’ sandwich boards. Only time will tell, but these ‘nervous Nellies’ are the perfect ingredient to a continued rally. This climb up the wall of worry is classic textbook price action.”
Mr. Arnold has been “opportunistically bullish” since November, and one more sign he sees will keep him on that path.
The rearview mirror
In the first few months of this year, investors embraced the safety of U.S. Treasuries. What could be more secure than government bonds?
Mr. Arnold consults a chart that tells him 10-year U.S. Treasuries outperformed stocks last year. No surprise there. But they have also outperformed equities on a trailing 20-year basis!
This has only occurred twice before in the past eight decades — once in 1932 and again in 1950. “As is typical fashion, investors look in the rearview mirror and extrapolate into the future what has just occurred, and hence, their thinking is that bonds must be the place to invest right now.”
But hold on. “When 10-year Treasuries have outperformed stocks over the previous 20 years, they have dramatically underperformed stocks over the next five years,” reports the analyst.
In the five years after 1932, the S&P 500 returned 33 per cent per annum, bonds just 4.6 per cent. Post-1950, the figure was 23 per cent for stocks, a mere 1.6 per cent for bonds.
“This is another bullish arrow in the stock market quiver,” states Mr. Arnold firmly. “At a minimum, do not chase the supposed ‘safety’ of Treasuries in today’s environment at the expense of investing in stocks.”
And here’s his last piece of counterintuitive advice. “Buy stocks ... especially on pullbacks. Sell U.S. Treasuries ... especially on rallies.”
He might have added this proverb: Those who spend too much time looking in the rearview mirror are sure to wind up in a rear-end collision.
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