Monday, March 10, 2014

7 red flags

Remember March 4, 2014 -- a day that will go down in Wall Street history as the beginning of the end for this latest bull market, which is celebrating its fifth birthday.

On March 4, the Dow Jones Industrial Average ($INDU -0.21%) rose 227 points based on a report that Russian troops were pulling back from Ukraine's border. This "news" lit the market on fire, a sign that the market is heading into a mania stage where it doesn't take much to boost stocks.

Indeed, nowadays instead of the "Nifty Fifty" stocks that defined the late 1960s market, we have the likes of Facebook (FB +3.19%), Tesla Motors (TSLA -2.99%), and Chipotle Mexican Grill (CMG -0.92%) -- the new new things.

Can the market go higher? Sure, although the higher it goes, the more dangerous it becomes. Often, during the latter stages of a bull market, the market separates itself from reality and appears to be on another planet.

Such red flags are everywhere:

1. Retail investors have been pouring money into stock mutual funds. The fear of missing out on the sixth year of a bull market has created something close to a buying panic. Although not as maniacal as we saw in 1999, the stock cheerleaders are back and rooting for their stocks and mutual funds to go higher -- just like they always do before a crash or bear market.

2. The Investor's Intelligence survey is concerning. The closely watched II survey shows a low proportion of bears (less than 20 percent), which some have pointed out is the lowest proportion since just before the 1987 crash.

3. Sentiment indicators are pessimistic. The VIX volatility index, the put-call ratio and other major sentiment indicators suggest that investors and traders are getting complacent. Apparently, market participants believe that the Fed, or their fund manager, will protect them in a worst-case scenario.

4. Fundamentals are being ignored. Obscenely high price-to-earnings (P/E) ratios are passed over, along with soft economic readings (i.e. GDP and ISM). When the fundamentals are weaker than expected, the weather is blamed.

5. The stock market crash of 2008 has been forgotten. Investors forget, but the market never does. Those who do not heed the lessons of the past will once again learn a painful lesson.

6. The Nasdaq is soaring. The three-year chart of the Nasdaq ($COMPX -0.04%) has gone nearly parabolic, hitting a 14-year high of 4,351 on March 4. It's the Go-Go years all over again. (And that late 1960s bull market ended with the 1973-74 bear market.)

7. Fear and greed are taking over. When the market reaches the tipping point (and we're getting closer), investors and traders buy "ATM" (anything that moves). The fear of missing out causes a buying panic.

What to do now
There have been numerous crash predictions over the last five years. As a result, many investors have closed their ears, and who can blame them? The market has ignored the warnings and continued to go up. One thing about crashes: They can't be predicted (but it won't stop people from trying). However, it is possible to recognize a dangerous market, which is what we have now.

The market is wearing no clothes

Just like the emperor, the market is wearing no clothes. Right now, many people see only what they want to believe. It's been a long time since investors felt full-throated fear, and many have forgotten what it feels like. The panic to buy will be replaced by the urgency to get out at any price. No one can know what will cause perceptions to change, but they will.

At the moment, emerging markets are in deep trouble, and what is happening in Ukraine didn't help. Nevertheless, the CEOs of several major brokerage firms have urged investors to "go long" emerging markets because they are so "cheap." Once again, these well-educated salesmen are wrong. Emerging markets will recover one day, but not soon. Urging investors to buy on the dip is disgraceful.

Sit and wait?
If we are in the mini-mania stage of the bull market, the market will continue to go higher based on rumors, hope, and greed. Sitting on the sidelines and waiting for the bull market to top out takes tremendous discipline. Trying to capture that final 5 percent can be costly if you get the timing wrong (and most people do). Be prepared for increased volatility as we get closer to the end.

Of course, it's not easy to sit on the sidelines when everyone else seems to be making money. Although many investors are dreaming of another 30 percent return this year, the odds are good that it will be a difficult year. Yes, during a mania stage anything is possible, but with each passing week, the clock is ticking.

Those who have studied market history have seen this story before, and the ending is always the same. No matter how many warnings you give, no many how you urge people to avoid buying the speculative Go-Go stocks and move to the sidelines, few listen until it is too late.

[on the other hand, Here's how the S&P 500 gets to 2,600 next year]

The S&P 500 is currently at 1877.  We'll see how much it goes up from here before tanking (who knows when)?

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Some comments:

David Strait The market will go down eventually but believing your prediction is no different than believing others who say it's going to continue to go up. If you say the same thing long enough if will eventually come true. The one thing I find is that there is no where else to put your money and get any kind of return so if you keep it on the sidelines you are losing money already anyway.    

Smeado Trying to predict market tops and bottoms is a fool's game.

robin1620 It's time to go all in.

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Here's what Hulbert says to do:

Few investors find solace from knowing that, if they wait long enough, stocks will eventually recover from a bear market. After all, as Keynes famously said, in the long run, we are all dead.

Yet history shows that typical bear-market recovery times are hardly “the long run.” Since 1926, it has taken an average of 3.3 years for stocks to surpass their high set before the typical bear market began.

Unless you think the next bear market and subsequent recovery will be worse than average, sticking with stocks is the best response to the certainty that, sooner or later, the current bull market will come to an end.

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And what am I doing?  I'm taking small profits bit-by-bit as the market goes higher and higher.  What am I selling?  Stuff that I won't really mind purging out of my portfolio plus trimming stuff that is looking expensive.

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