The Market feels a bit… “Toppy.”

5 03 2012

Jonathan N. Castle, CFP®, ChFC®

Where does the time go?  It is already nearly the end of February and it seems like 2012 is speeding along faster than last year!  So far this year, the financial markets have been reasonably good to all of us, with the S&P 500 up about 8.5%, the Dow up 6.6%, and the NASDAQ up an eye-popping 13.9% as of this writing.

The Dow Jones Industrial Index has broken through the psychological barrier of 13,000 – the highest it has been since March of 2008 a few times now.  In fact, the markets have been remarkably – almost eerily – calm for the last 3 months, quietly marching upward, shrugging off the occasional bad news (such as the Greek bailout nearly unwinding last week and the ever increasing tension over oil in the mideast) with little more than an occasional flinch. 

As we have said for the past 8 months, we remain cautiously optimistic.  “Moderately Bullish” is a term that I have used in the past.  Based upon historical behavior of Secular Bear Markets, we expect that over the next 3 years or so, we will see substantial ups (and downs) in the markets with a slight overall uptrend.  

As it pertains to the current rally, we believe this leg of the rally is probably due for a drawback of some kind.  The next chart shows our reasoning for this.  When the market approaches a point where it had difficulty breaking through previously (such as the Dow’s 13,000 level), this is known as “resistance.”  Typically, as a market index approaches a resistance level, it generally will pause, draw back, and then, IF the level is to be broken, will punch through that level to achieve new highs.  Similar to a person drawing back before breaking through a door, the market will generally draw back before “breaking out” to a new level.  As we are at that resistance level now, a drawback would be a natural – even necessary – part of a normal market rally. 

Despite the recent market rally, we do not feel it is time to break out any party hats on a new sustained bull market just yet.  There are a number of reasons to remain cautious about the markets:

  • According to the Investment Company Institute – the total inflows (new money) going into equity (stock) mutual funds from February 1st through February 15th was a little over 4.6 Billion Dollars.  While this seems like a lot, compared to the inflows to bond funds, which netted 15.2 Billion – it was just a trickle.  Clearly, investors are not ready to assume lots of stock market risk just yet, and the recent rally did not have the market breadth that would indicate the start of a new bull market.
  • The price of oil is going up.  Part of the reason is that US refineries shut down every May to retool to EPA requirements, so oil nearly always rises during this part of the year.  However – increased tensions in the mideast are also driving oil prices higher.  Higher oil prices mean slower economic growth.  As businesses must pay more for energy, they spend less on payrolls and other things which drive growth.
  • Europe’s financial situation is still quite a mess.  While it seems that the European Union is working feverishly to keep from imploding – and they may well succeed – the fact is that Europe is already mired in what appears to be a deep recession.  This will have a global impact, slowing growth in emerging markets as well as within the United States.
  • Our National Debt is a significant problem – and only getting worse.
  • We are in an election year, so significant economic policy will likely not be passed until next year.  Given the uncertain outcome of the 2012 elections, it is anyone’s guess as to whether any new policies will be helpful or harmful.
  • The Bush tax cuts are set to expire this year.  This expectation is curbing business spending.
  • And the list goes on… given the recency of the 2008 market crash, investors are not yet hungry enough for returns to take additional risks and dive head first into the markets. 

However – there are numerous reasons to be bullish as well.  Institutional investors are slowly beginning to see the opportunity in stocks – and have publicly stated their plans to acquire more stocks in their portfolios over the next several years in preparation for a future bull market.  Some reasons to own stocks – and to expect the market will go up are: 

  • Stock valuations are more attractive than they have been in decades.  Based upon the price of stocks compared to company earnings, stocks are cheap.  In the past, investors who loaded up on stocks at current valuation levels were handsomely rewarded over the next 10 years.  Institutions know this – and their demand for stocks during this period may well keep the market afloat.
  • We are seeing a new “flurry” of IPO’s (Initial Public Offerings).  New companies – such as Facebook – offering publicly traded stock for the first time.  Historically, when there are a lot of IPO’s, the market does well.
  • We are seeing a significant increase in companies buying back their own stock.  Not only does this activity boost the stock market – but it is also an indication of what company insiders think of the future prospects of their companies.  Who would spend good money to buy their own company stock – unless they believed the company woud do well?
  • Corporations are hoarding more cash than ever.  While initially this might seem a bad sign – it is a an indicator of the huge potential that exists.  Eventually, this cash will be deployed.  When it is – there is enough of it to have an enormous impact upon virtually all parts of the economy.
  • Currently, the dividend yield on the Dow Jones is a very attractive 3.07%.  So, hypothetically if the market only goes up 5%, an investor who owned the Dow Jones would reap over 8% in total return.  It is only a matter of time before return-starved pension funds, institutions, and corporations currently investing in Treasuries earning less than 3% begin to move money to other assets to seek greater returns.  When this begins, the market has the potential to move up very quickly.

This balance between bullish and bearish factors is a normal part of the recovery process, but makes for a challenging investment environment. In summary, we remain cautiously bullish, with an expectation for occasional market corrections which may exceed 20% or more.  Likely, it will feel like taking three steps forward, only to take two steps back.  However, we feel that reasonable gains are available with the correct strategy.  The most successful investors that we have worked with have carefully chosen their risk tolerance, and then invested in portfolios scientifically designed around that risk tolerance – and remained focused on the long term.  

This blog post is not personal investment, financial, or tax advice.  Please consult your financial professional for personal, specific information.  Indexes mentioned are a general barometer of the stock or bond market they represent.  You cannot invest directly in an index.  Past performance is no guarantee of future results.   

Certified Financial Planner Board of Standards Inc. owns the certification marks CFP(R), CERTIFIED FINANCIAL PLANNER(tm) and federally registered CFP (with flame logo) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.

Investment advisory services offered by Paragon Wealth Strategies LLC, a registered investment adviser.  http://www.WealthGuards.com 

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