There are two primary schools of thought about investing in modern markets. The first and dominant is what I call Live Long and Prosper with deference to the late Leonard Nimoy, Dr. Spock of Star Trek. It prescribes being fully invested at all times no matter what is occurring. If you live long enough, the uptrend will re-emerge and you will prosper in the long run.
The second is what I call Dynamic or Active Allocation. Using the analogy of driving a car, you travel at speeds safe for the conditions at hand. It makes no sense to drive at maximum highway speeds during an ice storm and no sense to stay fully invested in stocks during a greater than normal market correction.
For many years, I saw the industry piece that shows how badly a decade’s results would be if you had missed an index’s best 40 days out of about 2,500. But I had not seen the even better results if you instead missed the worst 40 trading days during the same decade. It’s a dramatic difference.
The industry mantra is that you cannot know the precise day to sell. The truth? You don’t need to know that. The trend is your friend.
So while the major US stock indices are generally at or near record high points, let’s examine how we can usually tell when the bullish trend is shifting into neutral and the bears will take over. I say usually because investing is a test of probabilities.
There are many indicators of market strength and weakness. Many watchers have their own preferences between different ones, but all are based upon price trend and trading volume. The building blocks of price are supply and demand. When demand for shares rises given a certain supply, price rises too. Therefore, a tell-tale clue to a market top is a decrease in trading volumes although price is still rising or attempting new highs.
Since identifying an exact top is difficult, often you will see it more clearly when the trend has reversed downward. When demand rises on days when price clearly drops, the investor needs to beware. There are also indicators that track large blocks of shares traded. If large blocks are being sold (usually by insiders or institutions) but the retail investors are buying on dips to finally get in or because stockbrokers are pumping it, don’t be afraid to take your profit or cut your loss.
I recall when a new client transferred in a few hundred shares of Enron. It had been about $50 but was then down to $22. Analysts and TV talking heads were still pumping it as a Buy. That large block indicator showed that the big guys were dumping it. We promptly sold it. Within 6 to 9 months, it was selling for about 50 cents after all of the skullduggery came to light.
So where are we now? As I write on the 18th of May, the S&P 500 index is making a new record high. But three of the four highest volume days in the past two months have been downers of 1 percent or so. The Dow Jones 30 Industrials index is also in record territory. The last truly remarkable high volume day for both was March 20th.
The NASDAQ 100 and Composite indexes are both cheaper than their recent closing highs of April 24 with losing days showing higher volume. The Dow Transportation Index is nowhere near its first quarter highs. Furthermore, bonds as measured by the iShares Core US Aggregate Bond (AGG) and Small Cap stocks are showing weakness. All things considered, I am skeptical that the bullish trend will continue through the summer. We could easily see a more major correction with a nice uptrend resuming in the fourth quarter.
(Past performance is no guarantee of future results. Advice is intended to be general in nature.)
