The Stock Market: Stop Listening to the Talking Heads

The past couple of years should give the home investor a sense of vertigo.  After climbing to a peak in late 2007, the markets descended further and faster than most predicted (to paraphrase Nouriel Roubini, how can he be considered Dr. Doom when the decline was worse that his forecast).  Then, after hitting lows in March of 2009, the markets have rebounded, with the Dow up 51 percent, emerging markets up 68% percent year to date, select stocks skyrocketing even further.  My own view is that there are some signals that the market is too bubbly in this recent runup and might correct by 10-20% before resuming a recovery.  Most of the markers I’m looking at have to do with investor psychology rather than market fundamentals.  Let’s examine some of these:

–News flow– I believe the best time to buy is when market pessimism abounds, and the best time to sell is when everyone is talking about buying or that the next trend is up.  Increasingly as the markets moved substantially higher through Q2 and Q3, the growing chorus of people saying it’s time to buy indicates, that it may indeed be time to do the opposite.  Indicator: medium sell signal

–Funds closing – I received a notice from mutual fund giant Vanguard that they were closing one of their top performing actively managed funds to new investors.  This is usually a sign of too much money chasing the winners.  If other top performing funds start to close, I would take this as an indicator that the froth is here.  Indicator: medium to strong sell signal

–Cash levels — the most recent data from mutual funds through the third quarter indicated that many investors were spooked from the losses they endured in 2008 and Q1.  In Q3, a lot of money went into balanced funds and balanced funds.  While it’s good to have a diversified portfolio, many of these investors missed the recent market rise.  Indicator: medium buy signal

–Historic patterns — one thing to keep in mind is that even though the Dow is up 51% from its recent lows, it is still down from its Oct 2007 highs.  The sharp drop means that a 51% rise is not quite symmetric.  If you have a longer term time frame, I would stick to a longer-term asset allocation and investment strategy and not try to time the market.

shared at this week’s Carnival of Personal Finance