Over the last few weeks we've been swamped with emails and phone calls from both members and non-members, wanting to know if they should sell their stocks. While we try our best to answer your inquiries as quickly as possible, sometimes it takes several hours. For now, our answer is still no - it would probably be a mistake for most of you to sell your stocks at this point. Unless you are already in retirement, or close to the point where you will start living off your investments, the best thing you can do right now is resist the urge to panic-sell.
Selling your stocks after the market has dropped by 15% or more, is almost always a mistake. That's because when you sell your stocks, you're making two decisions, not one, and you have to be right on both of them. First you have to guess correctly that the market will continue to go down after you sell. Then you have to guess correctly when the market has stopped going down, so you can buy your stocks back. The odds of being correct on the first guess - the sell decision - is 50-50. But the odds of being right on both the sell decision AND the buy decision is only 25%. In other words, the odds are against you by a factor of three-to-one. Guessing right twice in a row is hard, and that's why most people don't do well trying to time the market. On the other hand, staying in the market, and adding to your core holdings at bargain prices, is almost always better than trying to time the market.
There are situations where we do tell our subscribers to sell their stocks. Market timing isn't always a bad idea. The time to sell your stocks is when there is evidence that a recession is coming. We use a set of proprietary indicators that tell us when the odds of a recession are very high, and we advise our subscribers to cut back on their stock holdings when that happens. Right now, there is not enough evidence to indicate that we're headed for a double-dip recession. Our indicators have correctly predicted 8 of the last 9 recessions. The only one we missed was in 1980, and that one was followed by another recession in 1981, which we did predict. Unless we know that a recession is on the horizon, we treat all market drops as temporary. We use these market drops as opportunities to add to our stock holdings. This methodology has done well for our subscribers, as evidenced by the 11.95% average annual returns they've enjoyed over the last 20 years.
After a rally of 80% off the March 2009 bottom, the stock market has finally entered what we view as a normal (and much needed) correction. So far we've given back about one-third of the gains, and it would be well within normal trading ranges to give back half of the gains before this correction runs its course. If that were to happen, we'd be looking at the S&P 500 to bottom out at the 970 level before it finally stabilizes. This raises the question, why aren't we selling our stocks? The answer has to do with the difference between a recession-linked selloff, and a non-recession-linked selloff.
When the stock market takes a big hit like the one we're seeing now, one of the things it's telling us is that investors are fearful that the economy is going to tip over into a recession. If they're right about that, then the market will continue to slide, and the slide will last several more months. But when a recession fails to materialize, the selloff is shorter, and more shallow. Right now we don't expect to see another recession (the dreaded double-dip). Therefore we don't recommend selling stocks because there is more risk in getting out of stocks than staying in stocks. If we start to see real evidence of a new recession, we will change our stance on stocks. But for now, the mantra is take a deep breath, don't panic, and stay invested.
The fear of another global financial meltdown, accompanied by another crash in the stock market, is increasing with each passing day. While we don't completely rule this out as a possibility, our view is that it's unlikely to get that bad. For one thing, stocks in general are not far from fair value. As long as the economy continues to grow, earnings will continue to recover. The weakness in the stock market is being driven by fear, rather than fundamental changes in the economy. For the rest of 2010, stock market gains will be harder to come by, but we still believe that it's better to be in the stock market than on the sidelines. The next 7 months of 2010 will likely produce gains in the neighborhood of 12% to 15%.
What really caused the Flash Crash, and why is the market still so weak? We can see a combination of two factors. The first is widespread investor nervousness about the Greek debt situation. After an 80% rally, investors were looking for an excuse to sell, and they got it when it looked like the European authorities would not come through with enough financial support to save Greece from defaulting on its sovereign debt. News footage of riots in the streets of Athens certainly added to the sense of chaos and panic. The second factor was the out-of-control selling of stocks by computer-driven programs which have come to dominate trading on Wall Street. But we've seen this movie before. In October 1987, I was an equity trader for a Chicago-based hedge fund. I can clearly remember the eerie feeling of watching the stock market melt down in front of my eyes, and I couldn't get through to the floor of the New York Stock Exchange because of the prevailing chaos and panic. What happened that day in 1987 was a relatively new concept called "portfolio insurance," which meant that computers had been programmed to sell when the stock market started to decline. The problem was that there were too many of these computer-driven sell programs, and they swamped the few buyers who were left standing. It took most of the day, and part of the next day, for things to get straightened out. Last Thursday, by comparison, it only took about 20 minutes for cooler heads to prevail, and the market rebounded sharply.
It's not likely that we've seen the last of this correction, and we fully expect to see more turbulence in the weeks ahead. But we emphasize that this is an opportunity to buy good quality stocks at bargain prices. For a list of stocks, ETFs, and Mutual Funds that we use in our models,
click here.
The Big Picture
After making an all time high of 1,576 in October of 2007, the S & P 500 declined by 57%, to 666 (on an intraday basis). It's become increasingly clear that the bottom was made on March 9th, 2009. Since then, we've had a 14 month, 80% rally. We're now in the process of correcting an over-extended market, and a normal correction would be 10% to 15% from the recent high of 1217 on the S&P 500. That puts our downside target for this correction at approximately 1035 on the S&P 500 index. While we don't rule out the possibility of further weakness in the stock market, we believe the downside is much more limited than the upside. We're looking for a trading range on the S & P 500, with 1000 as the low and 1200 as the high. It will take a new shock to the economy to change our low limit, and it wll take solid improvement in housing, employment, and consumer spending in order for us to raise the top of the range.
What Would It Take To Change Our Bullish Outlook?
There are two kinds of problems facing the market today. First, there are the tangible, systemic problems such as high unemployment, foreclosures, and very high government indebtedness. Investors who are pessimistic about the stock market are focusing most of their attention on these tangible problems. (We delve into these issues in detail throughout the site.) Then there are perception problems. There are many market pundits who are still predicting financial Armageddon, but we're not among them. The equity market as a whole has decided that the risk of a total meltdown has subsided. The general perception among equity investors is that the economy is on the mend. In this market environment, perception is having more of an impact on prices than the actual numbers that are being reported. That's because the stock market is a forward-looking mechanism that places more importance on the events that are likely to happen in the future, than the ones that are right on top of us.
The longer term recovery in the economy and the markets is likely to be pretty bumpy. The structural damage that has been done to our economy will take years to heal. The days of 20%, 30% annual equity market returns are behind us, and probably will remain so for several more years. But we continue to believe that the policy response to the economic crisis has been correct. It's now likely that we will see continued improvement in both GDP, and equity prices for at least the next six months.
