Back before the turn of the century I became the newest member of a team that was managing a large sum of money. Obviously, I wanted to make a great impression on the group. A few months down the road the first stock I got into the portfolios was up sharply from its buy price. I jumped up and said we should sell it. We’ll make a nice profit and I'll look really smart. In unison the entire team asked why? I responded with, “It’s up a ton!” I thought it was a really impressive answer. Three members of the team gave me withering looks. One shook his head and said, “Son, I don’t think you get what it is we do here.” The last member of the team hit me with the classic, “Ya can’t be afraid to make money.” I quickly sat back down and kept quiet for the rest of the day. My boss told me that the point of this exercise was to make it clear that we actually want stocks to go up! “Let your winners run Tom, and be ruthless with stocks that do not perform.” Not the least bit complicated, but not at all easy at times.
“Disregarding the big swing and trying to jump in and out was fatal to me. Nobody can catch all the fluctuations. In a bull market the game is to buy and hold until you believe the bull market is near its end. Obviously the thing to do was to be bullish in a bull market and bearish in a bear market.” Jesse Livermore
I share the above story about my education in the industry, and the classic quote to help guide us through the current market environment. Last week I wrote about the often repeated “the market has come too far too fast” or “I’ll buy the next dip” comments that echo in our heads. Look, there are times when the market is going higher and there isn’t a thing that anyone can do about it. Buy stocks then. Sell stocks when the market starts going down. Like I said last week, price is above the 12 and 20 on the monthly, above the 4 and 12 on the weekly and the daily is above the 20, what else do you need to know? Watch TV or read the headlines for a host of reasons why the market simply can’t go any higher. They seem to make sense. All the potential negatives are out there. The weight of the evidence is being viewed as positive and stocks are going higher.
Everyone is aware that the unemployment rate is high, the banks aren’t lending, China is raising rates and there is turmoil in the Middle East. Also, the market hasn’t corrected in several weeks, no cash at mutual funds to keep buying stocks, the dollar is worthless, mortgage rates are soaring, states are going broke, Bernanke is a fat head...manipulation!!! (that will always be my favorite). With all that out there, the market goes up week after week. Remember, when confused, respect your elders and ask for advice.
“The most bullish thing the market can do is go up.” Stan Weinstein
“Well, you know this is a Bull Market!” Jesse Livermore
Find companies that are well positioned in strong industries that are reporting good earnings and giving good guidance. That is the strategy that is working now. Always works. The reaction to that news is what varies. Earnings reports are primarily strong. Companies that report earnings in excess of estimates are going higher, much higher. When CEO’s convey bad news, their stocks are hammered by aggressive selling. Makes sense to me. When this pattern changes, either reports are poor or the reactions become more muted to good news—reduce exposure to stocks.
There will come a time when this move in the market gets tired and it will be prudent to reduce your exposure. When will that happen you ask? Well, I could point you to some reports from several learned experts and come up with an algorithm that will pinpoint the top. Even though that would be complete nonsense, I could definitely do it. To answer your question honestly though, I do not know! No one has a crystal ball. Trying to predict the future course of a highly complex system is the holy grail of quants, scientists, and human-beings the world over. With that said, however, the threats I am looking at currently are rising interest rates, emerging market weakness, geopolitical chaos and surging commodity prices, which will eventually slow things down. There is a lot of information out there on these and several other potential issues. The market discounts everything. Price reflects all concerns. Right now the pros outweigh the cons and stocks are moving higher.
How high can the market go? In a piece I wrote on December 13th of last year, Riding The Fifth Wave, I put a price target on the S&P 500 of 1289-1292 for this run higher. Look at the chart in that piece and you can see at that time I thought we were in the fifth leg of five and this move would lead to a near term top. We have exceeded that target so it is time to re-evaluate. Some, that are far better at reading charts than me, say an alternative wave count is building. Perhaps we are still in the third wave; the fourth was just a correction in the powerful third wave. It is too early to tell.
“The public ought always to keep in mind the elementals of stock trading. When a stock is going up no elaborate explanation is needed as to why it is going up. It takes continuous buying to make a stock keep going up. As long as it does so, with only small and natural reactions from time to time, it is a pretty safe proposition to trail with it.” Jesse Livermore
How will we know when this market move is getting tired? Look to the following levels for signs that a pullback is getting serious: S&P 500 1275, Dow 11,800, NASDAQ 2676. If the market cannot hold these levels, a serious correction will be underway. If you see 1310 on the S&P, and 12,090 on the Dow give way, it is a good bet the first levels given will be tested.
But if after a long steady rise the market turns and gradually begins to go down, with only occasionally small rallies, it is obvious that the line of least resistance has changed from upward to downward. Such being the case, why should anyone ask for explanations? There are probably very good reasons why it should go down…”Jesse Livermore
So, when the charts begin to roll over and the bears take control, I will do some selling. That could begin next week, next month or maybe even next year. Reading the headlines and listening to the pundits isn’t going to help me all that much—never has. I will keep doing as much research as I can and look to the overall tone of the market through the charts of the major indices. When the reactions to market events begin to take prices down, sell stocks.
