Saturday, September 27, 2014

The natural gravity of stocks

Even in the remotest corner of the world, everyone understands the law of gravity. When you drop something ... it will fall to the ground.

Interestingly most investors don't really understand the natural gravity of stocks. In fact, they find every way possible to confuse matters with too much commentary, charts, and data.

Plain and simple, the gravity of stocks is to move up. Meaning that to move higher is their natural progression UNLESS an opposing force gets in their way.

I'd like to prove this point so you can better understand why stocks will continue higher into year end and into 2015. And to learn the signs of what will eventually lead to an overall market decline.

Growth is the Most Natural Thing in the World

I don't mean to get too philosophical here, but it is important to understand that advancing forward is a prime driver of the human condition. This innate desire to do things better leads to improvements in productivity and our standard of living.

It also creates greater economic activity, which is another way of saying higher profits. And profit growth is the main ingredient we investors seek when selecting stocks.

To boil it down:

Human advancement = higher economic activity = higher profits = higher share prices.

The above equation proves why the natural order of things is for the stock market to move higher. Unfortunately it's not all rainbows and lollipops.

Boom and Bust Cycle

One sad thing about the human condition is that we are also prone to believing that the good times will last forever. This leads to excesses during the boom times that pave the way for the next bust. (And often those excesses are about people, businesses and governments becoming over leveraged).

Here is the equation for a recession:

Lower economic activity = lower profits = *lower share prices
(*average stock market decline during a recession is 34%).

Gladly the average US recession only lasts about 13 months, while the average expansion enjoys a healthy 63-month reign. That means we are able to take five good steps forward for every one backwards.

What Does that Mean for the Future?

It should be clear by now that my premise is this:

Stocks will continue to advance until there are signs of the next recession.

Of course, I don't mean stocks will go up every day, week or month. I mean that the primary long term trend will be bullish until the odds of a future recession increase.

Right now the odds of a looming recession are very low. And so best, to stay in the bullish camp until some more ominous dark clouds emerge.

-- By Steve Reitmeister, September 272014

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