Will the bull market continue through 2010? Maybe. But you shouldn’t expect anything like the spectacular run-up the major indices made in 2009.
All but one of the 14 previous bull markets since 1932 survived into a second year, averaging 12.5% gains during that year. But that doesn’t mean this bull market will move in a straight line up in 2010. In fact, we may not see an advance at all.
I recently went over the serious potential bearish pitfalls that are in the cards, but this week I want to give you the “bull side” of the argument for 2010, because it’s important to understand the different possible outcomes. But, as always, you should trade based on what’s going on AT THE TIME.
‘Envious Money’ Still on the Sidelines
There is a LOT of cash still on the sidelines and the return you get on that cash, say in a money market account, is close to nothing. But it’s not exactly scared money like it used to be. “Envious money” is more like it. Most individual investors didn’t participate in the rally off of the March low. It’s been a low-volume rally, mainly in larger companies.
You may recall a report from Morningstar I mentioned a couple of months ago saying that, for the first eight months of the year, out of the top 10 funds that saw the largest inflows of capital, nine of them were bond funds. This shows the lack of participation from individuals.
At the March 2009 bottom, money fund balances peaked at $3.7 trillion. JPMorgan (JPM) said that since the March bottom, $560 billion has flowed out of money funds, leaving $3.2 trillion still in money markets. So, that leads us to believe there is a lot of potential for money to come flowing back into the stock market after a correction. Or, at least, it will likely move into one of the financial markets.
To further back up the idea that so many investors are waiting for a correction before jumping in, I’ll point out that Investors Intelligence polls more than 200 financial newsletter writers and investment advisers on whether they are bullish, bearish or looking for a correction.
The recent poll shows advisers who identified with “looking for a correction” increased to 35.1%, the second consecutive week with their highest number since March 1992, when they were at 35.3%.
What about liquid assets other than money markets? There are other cash or “cash-like” stockpiles out there like cash deposits, CDs, etc. The U.S. household sector currently has approximately $7.7 trillion in liquid assets, which is even higher than the previous peak in the 1980s.
What’s Everyone Waiting For?
And how has the market moved so much higher off the March low with all that cash on the sidelines?
Two weeks ago, I explained why and, more importantly, how the Fed is manipulating the equities market higher. Or, at least I explained one way that few people know about. (Check it out if you didn’t read it.)
I also told you the Fed is juggling between keeping the Treasury market and the equity market afloat (read: manipulation) at the same time. This is as dangerous and possibly as difficult as juggling knives with the handles on fire.
I didn’t explain this “behind the scenes” situation for the purpose of suggesting you start trading off of that info right now. It’s part of the story that you should keep in your back pocket, much like the looming credit crisis was “in the cards” when we wrote about it through the end of 2006 and in early 2007.
The reason why I explained the way the Fed props up the equity (and bond) markets was because you need to understand a large part of what’s been keeping the major indices (and, therefore, market sentiment) propped up. And once you get that, you start to understand how to detect when that trend may be ending, failing or just taking a breather.
But it’s too early to act on that knowledge, and too early to “position yourself” based on that knowledge. One of the biggest mistakes investors make is positioning themselves based on a compelling story, before it’s in motion and starts to play out.
Imagine if we got really bearish in late 2006. Instead, we waited until we saw institutions starting to sell out of the Wall Street stocks, and then we went to town booking bearish profits.
So, what advice can I give you right now on how to understand the market and the strength behind it?
Well, I can give you a very basic but very powerful concept that you MUST understand, when deciding when to invest, and where to invest.
Size Matters
This year, if you don’t do this already, I want you to stop focusing on the Dow Industrials. And if you are going to focus on the large-cap S&P 500 Index (SPX), then you have to also focus on the S&P MidCap 400 (MID), and the S&P SmallCap 600 Index (SML). Why? Because there are a heck of a lot more smaller companies than there are large-cap companies.
Since the high we reached in mid-September, the large-cap stocks advanced 3.9%, the mid-cap stocks advanced 1.6%, and small-cap stocks actually declined (even with the recent advance) by 1%.
Clearly, the small-cap stocks have been moving out of favor. But that’s not necessarily a bearish sign. Don’t confuse small-cap stocks with market breadth. That’s another story. (However, breadth is, in fact, weak.)
You might also notice something else. The drawdown since the mid-September high is bigger on the mid-cap index (7.6%) than on the large-cap index (4.7%), and the small-cap index drawdown since the September high is even bigger (9.5%).
Again, there are more smaller stocks than there are bigger stocks. So, if you threw a dart at a board, it’s more likely that you landed on a stock that moved a bit lower or traded flat than landed on a winner.
Here’s how the market is broken down:
- Large-cap stocks: $10 billion–$200 billion
- Mid-cap stocks: $2 billion–$10 billion
- Small-cap stocks: $300 million–$2 billion
- Micro-cap stocks: $50 million-$300 million
- Nano-cap stocks: Below $50 million
I will continue to bring you the big bullish and bearish arguments. Like I said, you must understand the stories that may develop (in the public eye) and why.
But the best way to trade, in my opinion, is to move based on what the market is doing currently and to focus on what sectors of the market are seeing institutional accumulation or distribution. And to significantly minimize risk without giving up profits, use option contracts! It’s by far the smartest way to trade.
This way, if you wake up one morning and some disaster caused the market to trade down 20% when you’re bullish, or a big event causes a huge bull run when you’re bearish, your loss will be minimal, and you can reconsider your market stance.
Understanding the market for what it is (i.e., a number of smaller groups of stocks, as opposed to a bunch of similar stocks all represented in one index), and not what the media has programmed you to think it is, is the first and most important step.
