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2005 started with the S&P 500 at
about 1212. My January 1, 2005 longer term comments, which I update
every six months, suggested that the market was due for a pullback after
a very strong second half of 2004. Having your indicators tell you that
there is a pullback due is a nice thing. The difficult part is knowing
exactly when these changes will begin. I was saying it could start
tomorrow, or next month, I just didn’t know for sure. Whenever it
started, my “guess“ was that the pullback would be between 10% and 15%
off the high, where ever that high was going to be.
The year started out with a plunge which caught me by surprise since
early January is typically a strong week for the market. I was going to
wait for a sign of weakness but the weakness knocked me upside the
head. So we had the start of that pullback.
Later, the market rallied again and the actual high for the S&P 500
didn’t come until March at 1229. The low during those first six months
came in April and was 1136, or about an 8% pullback from top to bottom.
Since then the S&P 500 rallied back to the 1220 area and I was looking
for another period of rest. That resting period seemed to have started
on June 23 and we are now trying to determine if this will be a short,
painful drop as we saw in 1994, or if it will be more like the 2004
summer sell off which lasted six weeks.
If I were to give myself a first six month of 2005 report card I would
say my market outlook calls were better than my actual actions. My
predictions were pretty good, maybe a B+, but the timing of a couple of
my moves in January and February caused my actual results to be in the
C+ area. They were nothing to write home about but nothing to be
ashamed of either. That 3% drop in the first week of the year had me
starting in a pretty deep hole but I’ve recovered some. I
narrowly beat the returns of the C and I funds, but the G, F and S funds
beat me.
Looking forward to the next six months is going to be a two part story.
I am really excited to what 2006 will have in store for us, but first I
believe the market needs to get through this consolidation period. That
could give us one or two more visits near the April lows. But I believe
that last dip will be setting up a great buying opportunity before the
year is through. So, we may see some good trading opportunities, and
the future looks good once we get by them.
Since I write these six month updates for those who do not want to
“trade”, but rather for those who want to put there money somewhere and
only make minor adjustments here and there, my suggestion would be very
similar to what I said in January. That is to raise 15% to 30% cash (G
fund) and use market pullbacks of 5% to 10%, to put it back into the
stock funds. As the S&P 500 approaches the 1215 to 1230 area, I would
lighten up again. It would have worked well during the first six months
and I believe it will be the best intermediate term strategy until
October or November.
I talk about the three legs of the market often; Valuation, psychology,
and monetary conditions. The market can sustain itself as long as two
of the three legs are intact. When you lose one, things can get shaky
but overall the market will still hold up pretty well. Lose two and you
better put up your defenses.
With bond rates still low and the S&P 500 earnings yield continuing to
climb, stocks are still the best investment looking out several months
and maybe years. That doesn’t mean the market will go straight up from
here, but it should be enough to give the market a cushion to keep it
from any significant damage. Most people can tolerate 5% to 10%
corrections and I don’t see anything much worse than that occurring this
year.
The psychology leg is the one that has been the most wobbly lately.
Coming off the big returns of 2003 and the strong second half of 2004,
investors seem to be back in the “buy the dip” mentality. (I do that as
well but I also sell the rallies in conditions such as these). One or
two more visits to the April lows will give investors something to worry
about, and that is when it will be time to plant the longer term seeds.
Nervous investors turn into good buying opportunities. As I mentioned,
I suspect that will come by the fall.
The monetary conditions tell us how much money is available and how
expensive or cheap that money will be to borrow. The Fed basically
controls this and it is in a neutral zone right now.
So we have a strong valuation leg, a wobbly psychology leg, and a
neutral monetary leg. This is the reason why I am not a raging bull
right now. If The Fed stops raising interest rates and the market can
consolidate for a few more months, I believe we will turn the tide and
head into another strong bull market.
Bottom line: If
there are going to be any major fireworks for the market this year, I
expect it to be later rather than sooner. Until then, use weakness to
add to the stock funds. Use strong rallies to lighten up. That should
keep your account in good shape for the coming rally which I suspect
will start late this year or early next year. |
