These are anxious, confusing times for investors. Though markets have stabilized a bit this week, people are pretty nervous, to say the least.
A shaky economy, Congress’s debt ceiling fiasco, Standard & Poor’s downgrading of the US, and a deepening debt crisis in the Eurozone are enough to worry anyone.
In fact, with the S&P 500 (SPY) having fallen as much as 17.9% from its recent April 29 peak (as of Wednesday’s close, it was up 6.5% from its lows), we may be on the cusp of a new bear market, as four leading technical analysts told me last week.
So, I was a bit surprised when I moderated a panel at the MoneyShow San Francisco, last Thursday, and four of the five panelists were bullish. Of course, I can’t recall a time over the last decade when most advisors weren’t bullish, no matter what the market was doing.
But one of them got my attention: James Stack, president of Stack Financial Management and editor of InvesTech Research.
Since predicting the 1987 crash, Jim has had a good track record of getting investors in and out of the markets in a way that limits their risks. (His newsletter has trounced the Wilshire 5000 over the last five and ten years while taking less risk, according to the Hulbert Financial Digest.)
Stack is conservative, while some financial advisors are still telling retirees to keep two-thirds of their money in stock. He also has tons of data and computing power accessible from his company’s headquarters in idyllic Whitefish, Montana.
And, as I’ll explain later, I’ve learned the hard way not to dismiss his views on where the market is going.
Anyway, he’s crunched the numbers, and he’s not ready to declare the bull market over yet. His favorite technical indicators aren’t waving any red flags, and he doesn’t think the economy is heading into a recession, double dip or otherwise.
He understands why people are wary. “Confidence has been and currently is still in a funk,” he told the audience. “What business would go out and expand and hire in anticipation of new growth and new opportunities, when all they see is they’d better prepare for battening down the hatches for that double-dip recession?”
Yet he thinks those worries are overblown. (You can watch my short interview with Stack, where he explains some of his reasoning from the longer speech, here.)
True, the Index of Supply Management’s manufacturing index is hovering just above 50; below that, it would be contracting. But the ISM’s service index has actually trended upward of late, and as you know, we’re predominantly a service economy. Also, jobless claims have moderated recently .
The indicators Stack looks at most, the Conference Board's Leading Economic Indicators (LEI), actually have been hitting new highs. “If we’re going back into recession, then why hasn’t this LEI fallen six to 12 months prior to this recession, as it has in every instance in the past 50 years?,” he asked.
(Lakshman Achuthan, co-founder of the competing Economic Cycle Research Institute, told The Wall Street Journal in June that we’re “not yet” heading into a double-dip recession, “but a sharp and prolonged downturn is under way.”)
“I think the odds are still at least 70% to 80% that we are not going back into a double-dip recession,” Stack told me.
That’s what the technical indicators are telling him, too. “In the last couple of weeks we’ve had a couple of days that are some of the most oversold days in the last 50 years,” he told me. “That’s typically how corrections end, not [how] new bear markets start.”
Plus, the advance/decline line (also called market breadth), which measures the ratio between the number of stocks that advance and the number that decline, actually hit a new high in July, weeks after the market peak between April 29 and May 2.
“There’s not a single market top in the past 70 years where...breadth kept going up after supposedly a bull-market peak,” he told me. “So, if this was an important, big market top back in April, it’s unlike anything we’ve seen [during that time].”
And on Monday, August 8, the number of declining stocks beat the number of advancing issues by an astonishing 77 to 1, a reading never seen in the past 80 years, Stack said. That’s usually not a sign of a bear market, either.
“What we’re seeing in the market right now is not an economically induced downturn that is a precursor of an imminent recession. What we’re seeing on Wall Street is more psychological, more emotionally driven,” he concluded. In other words, pure panic.
Stack conceded this bull market is getting a little long in the tooth. Since 1932, he said, the median duration of a bull market has been 3.6 years. If this one were truly over, it would be tied for the shortest bull market during that time.
But even if it has a way to go, he thinks investors should get more defensive.
“You don’t…keep pouring money into those sectors that are the strongest performers in the first year, because they tend to become the highest risk sectors as the bull market matures—financials, consumer cyclicals,” he said. That’s why he likes sectors like health care and energy, which tend to do well in the bull’s later stages.
What’s my take? Well, I was pretty bearish pretty early, having started warning investors about the markets starting in April.
I was worried about the economy, the European debt crisis, and our own debt-ceiling debate—all of which played big roles in the decline that followed. I’ve remained bearish since.
But I recall an extended, animated discussion I had with Stack in February 2009, in which I argued we were in a long secular bear market that would last a while. He said the market was close to a bottom, and it was time to buy stocks.
I had a lot of economic and technical “evidence” to back up my point then, too. Guess who turned out to be right?
I’m sticking with my view the market is going lower, but if the S&P holds its recent low of around 1,100 to 1,120 on the inevitable retest, then we’ll just have had a correction much like 2010’s 16% decline. If it goes below 1,100—and especially if it breaks 1,020 to 1,040—then we’re likely in a new bear.
I would use any rallies that take the S&P into the 1,200s to unload the riskier positions you still own, and either reduce your overall stock holdings or shift some money into defensive sectors.
Two defensive funds I like are Vanguard Dividend Growth (VDGIX), also recommended by Morningstar (and which I own), and T. Rowe Price Life Sciences (PRHSX). Roughly equivalent ETFs are Vanguard Dividend Appreciation (VIG) and the Health Care Select Sector SPDR (XLV).
Getting defensive at this point is a good idea, even if you think the bull’s not over. That way, you can protect your assets without having to outguess the market—or gurus like Jim Stack.