Last week's market sell-off, particularly Friday's 2.5% drop, was ugly. What happened to that for-sure bull market widely discussed earlier this year? Is it still there, so this a dip to buy? Or are we now in a bear market?
I expect that this messy market is offering opportunities and that we will see good returns in the future. However, I don't see the next bull market as an extension of the previous one. Here are the four changes in thinking that I believe will help achieve superior returns going forward.
Change 1 - Ignore reported macro "facts"
Everybody already knows the negatives behind Friday's sell-off, so there are no insights to be gained by belaboring them. To win at investing, we need to be insightful, meaning we have to focus on what's not being discussed. Moreover, macro thinking (and especially mega-fears) will be as damaging to returns this year as they were in 2010 and 2011.
(click to enlarge)
(Stock chart courtesy of StockCharts.com)
Change 2 - Ban trend line thinking
Remember the forecast competition in early 2011, with economists' ever-higher growth projections built off some good numbers? By mid-year, all became doom and gloom, this time founded on some weak reports. Then came this year's early forecast ramp up - based on good results, of course. Now, here we go again. A "bad" employment report and negative revision = a path to doom and gloom.
Trend drawing off of a limited set of data is bad analysis. So keep all such discussions out of your thinking.
Change 3 - Before selling, think long-term
"But I'm losing money now!" Yes, and that's why you need to shift the focus. Just like making money in the short-run doesn't mean you should buy, nor should losing be a trigger to sell. Rather, think about where we've come from and where we're headed. Also, think about how organizations and individuals have adapted to the post-Great Recession's conditions.
For example, remember the fears built on forecasts of housing's continued plummet, with a near-perpetual cycle of foreclosures = [shadow] inventory = price declines = foreclosures…? Instead, foreclosures are winding down, the inventory is being sold and prices are stabilizing. Moreover, rents have risen and mortgage rates have fallen, making the buy-rent decision swing more to ownership.
Change 4 - Beware of over-reliance on fundamentals
Beginning last December, a widespread bullish mood took hold, with analysts, pundits and investors enthusiastically focused on the market's steady climb and the "cheapness" of the stocks. The question that enthusiasm raised then was "why now?" Why didn't this analysis occur two years earlier when stocks had started their rise and fundamentals were improving?
I believe the reason stems from an oversensitivity to risk and a need for apparent perfection - i.e., good dividend yield and clear earnings growth and low P/E ratio and rising stock price and optimistic popularity. Because of that shift, I decided to sell all holdings in February (as I explained in "3 Steps To Winning In The New Bull Market"). My expectation then and now is that the stock market is shifting from the "old" bull market (into which people were buying) to a "new" bull market (with a focus on growth).
The bottom line
The "easy" earnings gains from leading companies are mostly done. These originated from the economic spring back from the depths, augmented by three "levers": operating leverage, financial leverage and pricing leverage (for more, see my Feb. 2010 article, "Use 'Springs' and 'Levers' to Revitalize Your Portfolio").
For this stock market, it's time to:
- Ignore reported "facts"
- Ban trend line thinking
- Before selling, think long-term
- Beware of over-reliance on fundamentals
I realize this view can seem non-intuitive and even irreverent. However, to me, it's a reflection of the changed conditions between the "old" bull market and the upcoming one.
To succeed in the "new" bull market, I believe we must focus on finding individual companies that produce outsized returns from true growth. While technology is a favorite sector when thinking about growth, any sector/industry contains companies that can produce high growth. The challenge is finding them. I will discuss my approach next time.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: Positions held: Long U.S. stocks
