I have maintained a generally upbeat outlook on global markets since last summer’s low, expecting stock markets to climb the proverbial “wall of worry.”
Indeed, markets have managed to dodge a number of obstacles in recent months including: The 2012 edition of the euro-zone debt crisis, divisive election year politics here in the U.S., and of course fiscal cliff worries.
But through it all, one of the biggest factors working in favor of higher share prices has been pessimistic investor sentiment, which as usual, built this wall of worry for the S&P 500 to climb higher by 17.6 percent since June 2012.
This highlights an important lesson from legendary investor Warren Buffett who says investors should attempt to:
“be fearful when others are greedy and greedy only when others are fearful.”
That’s why I cringed during my weekend reading when I ran across this story in the New York Times: As Worries Ebb, Small Investors Propel Markets. With this frightening array of obstacles seemingly overcome “Americans seem to be falling in love with stocks again.”
As I wrote in a recent Money and Markets column, as investors we must be wary of the consensus view and be willing to break from the crowd. We all know from experience, that investor sentiment is a notorious contrary indicator, or as the column states: “investors tend to buy and sell at precisely the wrong moments.”
Greed is on the Rise
The S&P 500 Index has more than doubled since the March 2009 low, and is now within sight of its all-time high of 1,565 notched in 2007. Likewise, investor optimism is on the rise too. “The level of bullishness among small investors has nearly doubled just since mid-November,” as the Times article attests.
In fact, the American Association of Individual Investors (AAII) sentiment ratio moved into over bought territory recently and now stands at the highest level since before the market peaked last March.
Also, investors are shifting their asset allocation back toward stock mutual funds again. In the last three weeks alone $14.9 billion has flowed into stock mutual funds — the most since 2001!
|Investors are pouring money into stocks again.|
But that’s really just a drop in the bucket compared to the $592 billion investors have drained from long-only stock funds since 2007.
So it may be premature to label this subtle shift in asset allocation a buying stampede. Most important, the uptrend in most global stock markets remains intact at present.
A simple way to determine this at-a-glance is to look at a one-year chart of any major stock market index, like the S&P 500 below.
One of the simplest definitions of an uptrend (as seen above) is that:
#1: Prices remain above their short-term (50-day) and longer-term (200-day) moving averages
#2: The short-term moving average (50-day) is above the long-term (200-day) moving average and
#3: Both moving averages are on the rise.
Surveying the stock market as of Monday’s close, we see check, check, and check.
The only caveat is this; the further above these moving averages prices climb, the greater the odds of a pull back in stocks.
The S&P 500 Index is about 5 percent above its rising 50-day moving average right now. The market was similarly extended in April and September 2012, just before corrections set in.
This doesn’t mean you should sell everything and wait for a pullback that may never come or at least not for a long time and perhaps from much higher prices.
However, it does mean you should exercise some caution when investing new money and avoid chasing stocks that are already extended.
Above all, watch your current investment holdings carefully and set stops on positions to help preserve profits.
There are Times to Buy
and Times to Sell
This reminds me of sage advice from another legendary investor: Sir John Templeton. Among his 16 Rules for Investment Success, Templeton stressed being open-minded and flexible with your investment approach.
“There are times to buy blue chip stocks, cyclical stocks, corporate bonds, U.S. Treasury instruments, and so on. And there are times to sit on cash,” Templeton wrote.
In other words, follow an all-weather investment approach that gives you the opportunity to invest in all major asset classes when appropriate: Stocks, bonds, commodities, currencies and cash, an often overlooked but important asset class.
Your goal should be to stay invested in the best asset class for the majority of the uptrend. Above all, remain objective and monitor your investments closely. And when the trend changes, be nimble enough to change your approach and move on to an asset class with greater potential.
Sir John put it best: “The fact is there is no one kind of investment that is always best. Expect and react to change. No bull market is permanent. No bear market is permanent.”
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