Who is Buying This Rally?

by | Feb 21, 2013 | General

Is it the “Smart Money” or the other kind?

“We simply attempt to be fearful, when others are greedy and to be greedy only when others are fearful.”– Warren Buffett.

It is easy to know when everyone is fearful—we all seem to panic at the same time—and therefore market bottoms often are “V” shaped. 

Not so with tops. We become greedy over time and for that reason, tops are sometimes long drawn-out affairs. Stocks and industries roll over one at a time until we look back and say, “Oh yea, that was it for the market.”

We don’t know for sure if a market top is forming, but since the last major market bottom was four years ago and gains from there are way over 100%, it makes sense to at least wonder how much is left in the current bull.

Below we compare 2013 with 2009 (a major market bottom) and 2007 (the last major top):

  Feb 2009 Feb 2013 Oct 2007
Past 1 Year Price Change -42.8% +12.1% +12.4%
Past 1 Year Earnings Growth -28.1% +0.9% +9.4%
ValueLine’s Market Potential +185% +45% +40%

The similarities between now and 2007 are interesting. In fact 2007 looked better since earnings had not yet stalled out as they have in the last year. 

The most intriguing series is the last one, showing the potential stock market gains in the next 3 to 5 years. ValueLine has been making this calculation since 1964 and while it is of little interest most of the time, when it pushes to extremes it pays to listen. +45% may not look like an extreme reading, but this number never goes negative—the lowest I’ve ever seen is 30%. This reflects the long-term bullish bias in the stock market. Most of the time the Market Potential fluctuates between 70% and 100%. 

However, when it gets below 50% we should expect much less from stocks and when it jumps past 150% we should be buyers.

But what about the question posed in our title? I’m concerned that some of those buying this market enthusiastically are investors who have been watching from the sidelines for much of the last four years. We think it might be late in the day to play catch-up.

Our caution concerning stocks has not helped our performance this year, although we continue to make money at a respectable rate. We would be delighted to be wrong in our caution and if the indicators we are watching turn up, we will be buyers. But until then our focus will be on preserving client capital rather than working hard to increase it.

Best regards,

Daniel A. Ogden

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