Monday, May 4, 2015
Today, we're doing something much more valuable than covering a single stock recommendation... or sizing up a commodity trade.
We're doing something that will help you make the right investments, right now...
We're sizing up the big picture in stocks.
Regular Growth Stock Wire readers know we often like to take a step back and look at the big picture. We look at the long-term trend of the market... we look at valuations... and we look at what investors think about the stock market. This big-picture thinking alerts us to both opportunities and warning signs... and it helps guide our trading approach going forward.
After studying the big picture, we may want to increase our exposure to stocks. Other times, we'll want to decrease our exposure to stocks.
Today, we'll look at the market through three different "lenses": sentiment, valuation, and price action... And we'll show you what it means for your portfolio.
Let's start with investor sentiment...
Investor sentiment is what's called a "contrary indicator." Investors are usually very bullish (expecting stocks to go higher) at market tops, and very bearish (expecting stocks to go lower) at market bottoms. So it's a warning sign when folks are wildly bullish... And when they're extremely bearish, it's a sign stocks are probably ready to rally.
One way we gauge investor sentiment is by looking at a survey published by the American Association of Individual Investors (AAII). Each week, it asks its members – mostly "mom and pop" investors – what they expect from the market over the coming six months.
The results of the latest survey aren't bullish or bearish compared with historical results... They're neutral. (You can check the AAII survey, right here. There's an interesting article about using the AAII survey as a contrary indicator on the site, right here.)
Our colleagues, Steve Sjuggerud and David "Doc" Eifrig, have found other evidence showing investors aren't overly bullish right now...
In a recent DailyWealth essay, Steve cited a USA Today article that said less than half of Americans are invested in stocks. According to Steve, "This is important news... The stock market typically doesn't peak until the largest percentage of the population is in the market."
In another recent DailyWealth, Doc showed that investors are buying blue-chip dividend stocks over other types of stocks. It's a sign folks aren't going wild with speculation. They're plowing into the market's most stable companies.
Based on the current market sentiment, there's still room for stocks to run higher.
How about stock valuations?
We like to look at the valuations of individual stocks to help us determine how safe it is to buy them... or to "trade for income" (our term for selling options on cheap, blue-chip stocks). You can do the same with the overall market...
When the stock market is extremely expensive, it's a good idea to sell some stocks and hold more cash. When they're cheap, it's often a good time to buy.
Over the last 60 years, the average price-to-earnings (P/E) ratio of the benchmark S&P 500 index is 16.5. Today, it's 18.4... a little more expensive than average.
But back in January, Steve wrote, "you can't just look at the P/E ratio by itself... You have to look at the economic situation." He shared his True Wealth Value Indicator, which takes interest rates into account. The basic idea is that when interest rates are low, stocks are more attractive by comparison... So they deserve a higher valuation. (Learn more about this idea in his essay: Nearly Six Years In... And Plenty of Upside Remains.)
When you take interest rates into account, stocks still aren't expensive today (relative to their historical average). Again, this means they have plenty of room to run higher.
Finally, none of the above indicators mean anything if the price action is weak...
In January, we told DailyWealth readers the number one thing that would lead us to think a bear market has officially arrived is something called "lower highs and lower lows."
Markets don't move in smooth, straight lines. They move in stair steps. A bear market tends to take a few steps lower... then a step or two higher. The steps backward are larger than the steps forward, and this produces losses over time.
A bull market does the opposite. It takes a few steps higher... then a step or two lower. You'll see that on a chart with a series of "higher highs and higher lows." That's what we've seen in U.S. stocks over the last six years.
What should you do with this information?
Investor sentiment isn't extremely bearish... And stock valuations aren't super-cheap... So there's no reason to take out a second mortgage and buy stocks aggressively.
But investors aren't all that bullish, either... And the price action shows stocks are still in a major uptrend.
This leads us to the conclusion that we need to stay long the stock market... especially through conservative, income-producing "trading for income" positions. (If you're not familiar with the idea of selling puts and covered calls, you can learn more about how these strategies work here and here.) This gives us a great blend of upside and safety. It's the right way to trade today's market.
Brian Hunt and Ben Morris
Most Growth Stock Wire readers are familiar with selling options on cheap, blue-chip stocks. But people probably don't know the hidden force that helps this strategy produce consistent profits. "Once you know this secret, you'll start to find all kinds of new, low-risk trading opportunities in the market," Brian Hunt writes. Learn what this hidden force is right here.
"People say option trading is risky," Jeff Clark writes. "But it's not the option that's risky. It's the strategy. And when used the right way, options are far less risky than trading stocks." Learn how to reduce your risk in the market with options right here.
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