The Stock Market
The Smart Profits Report: Issue #427
Thursday, June 7, 2007
The Stock Market: A Tale Of Two Bulls… 2000 Vs. 2007
By D. R. Barton, Jr.
Quantitative Analyst, Mt. Vernon Research
The stock market is currently a financial version of the Energizer bunny - it just keeps going and going.
And with the stock market hitting lofty heights, we’ve got three types of investor right now:
- The Giddy Optimists: Those who think things are different this time, and that the market will just keep rising to the moon. This group includes everyone on the brokerage or sell side who makes big bucks when the market is hot.
- The Rationalists: These folks are waiting for the bottom to drop out - the perma-bears, plus the rational technicians and fundamental analysts who wonder exactly where the jet fuel will come from to keep this rocket soaring.
- The Hopeful Crowd: These people are investors who’ve latched onto the rally and just put their money in the market, hoping that things work out.
One fact is certain, though: Every investor would have to acknowledge that this is one mighty impressive stock market run. And while nobody can predict with absolute certainty where this thing is heading, that doesn’t stop plenty of folks from weighing in.
Has The Wall Street Journal Got The Stock Market Wrong?
Enter the respected Wall Street Journal, which ran an interesting article recently, arguing why the market is not like the “old times” in 2000 when the last great bull run ran into some tough sledding.
Let’s look at the points the article makes and see how we can apply them to our own investing…
Stock markets that are barreling along non-stop in one direction are always eventful - and this one is no exception. But can the rally continue? The WSJ article lists three reasons why stock prices might not be overpriced yet. But I believe two of the three are weak, and the third is pretty suspect…
- Price-To-Earnings Ratios Are Low: Yes, price-to-earnings ratios (P/E) are indeed at relatively tame levels. At an average of about 17.8, it’s only slightly above the 17.0 figure generally considered the “line in the sand” that separates an expensive stock market from a market trading at a “good value.”Counter-point: But the main reason that P/E ratios are as low as they are stems from the fact that great corporate earnings have driven the ratio down, despite an exceptionally strong stock market. The WSJ does point out that corporate growth is slowing, but many economists believe that earnings are as overblown as stock prices now. And if earnings drop across the board (and this is more of a “when” than an “if” scenario), then the P/E ratio of the market will head back up.
- Yields Are Higher Than In 1999: The dividend yields of the S&P 500 are 60% higher now than in 1999.Counter-point: Comparing yields to one the biggest bubbles in stock market history is really more like “damning with faint praise.” It’s kind of like saying, “Yields are below historical averages now, but they’re not nearly as bad as back in 1999.”
- Stock Market Breadth Is More Favorable Now Than In 2000: The WSJ points out that back in 2000, tech, media, and telecom stocks made up a much larger capitalization portion of the S&P 500 in 2000 than they do now. And their climb was what fueled the bubble.Counter-point: Today, the Nasdaq (largely made up of those tech, telecom and media stocks) is precisely the index that is lagging the Dow and the S&P 500 during the current upward charge. So although there is a broader based rally now, it’s by no means inclusive. Stock market breadth basically means the number of winning stocks versus losing stocks on a given trading day. In fact, this so-called “technical breadth” of the market is actually lagging - a key warning sign that the stock market’s advances are not sustainable.
The best course of action for you to take right now is to continue participating in the bull run, but realize that the stock market is overbought. That means you need to be very alert to quick changes. Hitting another “air pocket” like we did on February 27 (when the Dow shed 216 points) is a very real possibility.
Protect yourself by making sure that your protective stops are in the right place. And keep moving them as new profits are captured. Enjoy the ride up, but make sure you have an exit strategy for when the bus starts heading down the hill.
Great trading,
D. R. Barton, Jr.
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Today’s Smart Profits Action Center
- Over the past few years, investors have cashed in on the stock market’s momentum by favoring small-caps over large-caps, growth stocks over value stocks, and emerging market investments over developed markets. But you still need to strike the right balance between maximum returns and minimum risk. Always use a trailing stop to protect your profits, and consider covering your bases with investments like bonds and precious metals. When the next pullback or correction hits, you’ll want to be prepared in advance, as it’s usually too late to do much once it gets started.
- Whether you want tips on how to allocate your assets properly… five ways to lower your risk and improve your returns… ten key rules of trading… or even the one investing rule that’s worth $52 million, learn how to build and protect wealth, just like the pros, using 31 tried and trusted moneymaking strategies - direct from some of the world’s most respected and successful money managers. Visit this link for more details.
Related Articles:
- Asset Protection Plan: How To Avoid 3 Mistakes That Will Cripple Your Investment Account
- Stock Index Comparison: Here’s How To Play Both Correction or Breakout Scenarios
- Timing Your Trades: Two Ways to Expand Your Thinking And Your Profits
The Chart Of The Week
Since the end of the market’s pullback in early March, the four major stock indexes (S&P 500, Dow, Nasdaq and Russell 2000) have all performed strongly. As the chart shows, they’re up between 8% and 11% - pretty good for just a couple of months’ work. But lest we get too giddy about the U.S. performance, note that Latin American stocks - represented by the iShares S&P Latin America 40 Index (AMEX: ILF) - have been up almost 40% in the same time frame. The U.S. is still the world’s financial leader, but if the rest of world starts to fall, the U.S. will follow in our inextricably linked global economy.
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