This Market Requires Prudence and Patience

by: Bill Cara

I truly am frustrated with sales people who stretch the facts and mislead the public with stories that there is a new Bull market happening now. It just isn’t so. Let’s review some facts.

The median of estimated Price-Earnings Ratios of all (U.S. traded) stocks with earnings is presently 18.5. At the market high (May 5) earlier this year, it was 19.6. At the market low (Oct 9 2002), it was 14.1.

The median of estimated dividend yields (next 12 months) of all noteworthy dividend paying stocks was 1.6 pct at the earlier market high (May 5). At the market low on Oct 9 2002, it was 2.4 pct and today it is down to 1.6 pct again.

This data comes from Value Line, which reviews in detail 1700 stocks, including foreign stocks and ADR’s listed in the U.S. The survey and methodologies and stocks under review cannot be questioned as to their accuracy in reflecting equity market conditions in the U.S.

Value Line, as you know, uses a disciplined methodology of estimating 3 to 5 year appreciation potential for each of these stocks. You see that in the free Dow 30 reports that I link to.

The estimated median price appreciation potential of all 1700 stocks in the hypothesized economic environment 3 to 5 years hence was +115 pct at the market low of October 9 2002, and just +40 pct at the market high earlier this year (May 5). Today that number is just +35 pct!!!

What Value Line is stating is that your total price appreciation (not your total return, which includes dividends) is most likely going to be +35 pct over 3 to 5 years. But if you were to use annual compounding, that’s a terrible return.

You can easily find a very high quality 5 year zero coupon bond today and hold it to maturity for a gain greater than +35 pct. I suspect you could even buy income-producing real estate that would provide far superior returns.

So why do equity sales people get so bullish today? I don’t know. To me, for the past year, it’s been a matter of wealth preservation rather than a period for wealth appreciation.

And when the market completes a Bear phase, I’ll be ready to totally commit capital once again across the board. I will have already identified stocks with 12-month Price Targets that would give me a possible Total Return (including dividends) of +60 pct to +100 pct or more, and I’ll be locked and loaded, ready to fire.

But, here’s the caveat. Market cycles are not always harmonic across the board. There could be a rolling Bull and a rolling Bear in which case it is the individual stock sectors that cycle through a market that is out of sync.

Take this as an example: if all 10 sectors topped and bottomed simultaneously, there would be extreme highs and lows for the major market indexes. But if the ten sectors each topped and bottomed at different times, the broad market highs and lows would not look so bad.

Let say the latter case happened – where sectors were taking turns in each intermediate cycle to hit a low. That means there would always be sectors hitting highs at the same time as others were hitting lows. Then, with all the intermediate cycles – adding up to possibly 10 rather than the traditional three – there would not be an extreme cycle high or low.

But if over the period of a whole Bull and Bear cycle, these highs and lows were aligned, there would be those extreme highs and lows.

If you perhaps don’t fully comprehend, let’s look at what happened to the Dow 30 today. The high-low-close happened to be: 12241-12134-12227. But I can assure you the DJIA did not hit a high today of 12241, nor did it hit a low of 12134. At no point during the day were these numbers reached.

What did happen is that the highs of each of the individual Dow 30 stocks were calculated to create the daily high, and the lows were similarly calculated to create the daily low.

During the day, the 30 Dow stocks hit those highs and lows at different times, so that at any specific point in time the DJIA looked different than it appears to you in the final tally. So the volatility looks so much more than actually happened.

With ten market sectors, the same thing is happening within a market time frame. They are all topping and bottoming during a long period at different times.

So as long as too many of these stocks and sectors don’t go to extreme prices simultaneously, creating the ultimate harmonic cycle, you and I will find it difficult to trade if we are always looking for a broad market bottom to enter and a broad market top to exit. There, in fact, could be what I called the rolling Bull and Bear.

That’s a good reason why I break the broad market down to sectors and sub-sectors and then apply my Accumulation-Distribution methodology to each.

Of course it was hard to write to long-term readers in July that I could see a cycle bottom for the Tech sector, but it happened; I called it; and the follow-on results were there to see.

Yes, I didn’t think the July bottom would produce a Bull run for 4 months, but that’s the nature of markets. Until something happens, you can never be sure it will. All you can do as a trader is to follow the simple rule: (i) protect your capital before trying to grow it; (ii) stick to stocks of quality companies, and (iii) try to stay on the right side of trend and cycle phases of those stock prices.

I could continue until my fingers can no longer type words, but the story is never going to change. There is a discipline to successful trading; it’s not easy because trading is as much art as science; and there are people and organizations out there who know you have wealth and they want it, and will say and do whatever they think it takes to get it.

Just accept that, as in life, there is bad as well as good in the capital markets, and it’s up to you to find the way. In time, prudent and patient traders get there. They deal in facts and with discipline.

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