Bullish but waiting

Fighting the tape may not be the best strategy.  The tape, which is the old term for market action because years ago stock quotes would come over the ticker tape machines, is quite strong at the moment. 

I am getting antsy.  I have been patiently waiting for the better part of eight months for our market indicators to flash a long term buy signal.  We’ve had a few short term signals but I have been hesitant to risk my money, and more importantly your money, in the stock funds when I don’t have a clear long term buy signal.  It is long overdue.  Yes, the market has had some nice rallies over the past several months, but from a risk / reward standpoint the relatively small gains (compared to say 2003) have not justified throwing caution to the wind to this point, but if we ever get oversold again (and we will eventually) that could be changing.

The market has not been deeply oversold since late October.  It would be so nice to see it get to that point again.  But you can’t always wait for all your ducks to line up to jump into stocks because you’d probably wait forever, as this past eight months has felt like.  However, being oversold, if not deeply oversold, is one thing I must wait for.  The market doesn’t necessarily have to crash to get oversold.  It can be a slow decline or even just steady sideways action.  When that happens, the indexes become like a coil ready to unravel.  A market that is in deep need of a rest, which becomes oversold by merely moving sideways for a period of time, can lead to explosive gains.  Perhaps that is the best we can hope for rather than a decent pullback.

And because of that, if the market does become oversold it doesn’t necessarily mean we will be able to get in at a lower price.  If that is the case our patience will not have been rewarded, but it will be a higher risk / reward entry point.  Being somewhat overbought as it is now brings with it more short term risk. 

The dilemma is whether to wait that long because the more people who are thinking along these lines of “I’ll wait for an oversold condition”, the more likely the market will continue climbing the proverbial wall of worry we keep hearing about. 

Looking at the Russell 2000 small cap index, you can see that it has been in a strong uptrend for quite some time.  But it is so tough to bet aggressively on continued gains in small caps when it is so dangerously close to the upper end of the trading channel. 


                                  Chart provided courtesy of www.decisionpoint.com


I really want to be bullish but I don't want to lose money when my indicators are not yet happy.  Those three legs of the market I talk about all the time are what I am watching.  The psychology leg and the monetary condition legs are leaning the wrong way and need improvement.  If one of those legs can come to the other side and join the valuation leg, which has remained very bullish, I would get on the bullish bandwagon very quickly.  The strong valuation leg is what has kept the market afloat the past nine eight months.  Let's go over it real quick:

The current earnings yield for the S&P 500 is 6.75% (S&P price / 2006 earnings estimate).  The current 10-year treasury note yield is 4.58%.  One of the best ways to measure valuation is to compare the yields of the two.  This tells us that stocks are currently 32% undervalued. 

                                              6.75 - 4.58 / 6.75 = 32%

It has been near 30% for about two years now and as I mentioned, the reason I believe stocks have held up so well. 

These figured were almost exactly reversed back in early 2000 making stocks extremely overvalued and we all know what happened to stocks between 2000 and 2003.   

That’s all for today.  Still bullish long term but waiting, and waiting, and waiting.  Currently 65% G fund, 35% I fund.  Thanks for reading.  See you tomorrow.
 

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