Follow the Drill

Today’s piece is going to be short. I want this little missive to stick with you and make you think. Hopefully, it will assist you with forming your own definitive investment strategy. A strategy you can use regardless of the market environment.

I am going this route today based on some things that I have persistently heard over the past several months. Some have pointed to concerns that make them pessimistic about the market. While I am not suggesting you put on blinders and ignore concerns, things need to be put into proper perspective. 

“Volume wasn’t what we wanted to see.” I have read comments like that on every advance since the market bottomed in 2009. But, if you closely analyze the market since the 2009 bottom, volume is just fine. How do I define just fine? From the lows volume on moves higher has been greater than downside volume. That covers volume for me. I am confused at what the volume bears are looking for. Are they looking for some number? If there is greater upside volume than downside volume then the market is healthy. Certainly there is less leverage and proprietary trading in the financial sector, but I do not think it is necessary to go too deep into the analysis. More buyers in good markets than sellers in bad markets, sounds good to me.

People either view the markets from a top-down or bottom-up perspective. Those that take a top down view look at the overall macro environment and then try to determine which sectors will benefit in that environment and then choose individual stocks. Bottom-up stock pickers will look at individual companies and select those they feel offer the best prospects going forward. They will construct portfolios consisting of their best ideas.

Let’s take a look at the top-down approach. There are endless sources to give you an overall global economic view. Every brokerage firm on the planet came out with their 2012 forecast. These forecasts consist of hundreds of pages of analysis with chart after chart, graphs, correlations, and moving averages. As part of my job I read all of these things. After reading 20 or 30, frankly I do not come away with all that much. Hey, smart guy, is the global economy getting better or is it getting worse? How did you come up with that and how do I know when things are changing? I guess if they came up with concise reports they feel we would be unimpressed. So, for me, I need a solid read on things that I can understand and track. For me, the most effective way to track the global economy is through the Leading Economic Indicators (LEIs). They have been improving for several months now. The market is up over 20% from last October’s lows. For me, as long as the LEIs are improving stocks should perform well.

That is all well and good but how do I find good stocks? When should I look to add to stocks? 1-2-3-4. I keep things simple. Stocks are basing (1), advancing (2), topping (3) or declining (4). I try to put as many 1’s and 2’s in my portfolio as I can and sell the 3’s and 4’s. The trend in how many stocks are in each category will give you a pretty good idea of how the market is doing. At the close of trading last Friday 74% of the stocks in the S&P 500 were basing or advancing and 76% of secondary stocks were in those categories. So, in the current environment you have a better than 7 out of 10 chance of picking a winner.

I am neither a bull nor a bear! I try to be bullish when it is prudent and bearish when the facts tell me that is the best viewpoint. What is my take on things now? The global economy has been improving for several months; the LEIs are my guide here. The charts are telling me that there are more attractive stocks each week. Therefore I am constructive on the market. When things change I will plug this incremental data into my own template and make the appropriate changes. That is my drill. What is yours!