How do you keep your trading on track in a go-go market that could turn down at any time? Use a simple trading diary to record your reasoning, and use that to guide your next move, writes MoneyShow's Jim Jubak, also of Jubak's Picks.
We've got a momentum market right now. And it's a particularly tricky one, since investors have to follow two momentum trends in their buy/sell/hold decisions.
That's why I'm finding the investment diary I keep especially valuable right now.
Let me start by telling you about the two kinds of momentum I see driving global stock markets right now. Then I'll explain what kind of investment diary I keep and how it's useful in this environment.
The first kind of momentum is your everyday, garden-variety momentum. Investors and traders buy stocks, which drives prices higher, because they see stocks moving higher.
On Wednesday, the Standard & Poor's 500 Index (SPX) stock index rallied for the sixth trading session in a row. The index had set new five-year highs over four days. For the day, new highs on the New York Stock Exchange outpaced new lows 357 to 7.
I remember checking in just before noon and being stunned at the list of stocks that had already set new 52-week highs: BlackRock (BLK), Cree (CREE), Walt Disney (DIS), Lennar (LEN), Marathon Petroleum (MPC), Monsanto (MON), National Oilwell Varco (NOV), Novartis (NVS), Southern Copper (SCCO), Stryker (SYK), and Weyerhaeuser (WY), to name just a few.
I remember scanning the list and thinking, "What should I buy? I don't want to be left behind."
And the run continues. On Thursday, the S&P rose slightly for a seventh straight up day, briefly trading above 1,500 for the first time since Dec. 12, 2007.
That is the sort of thinking that drives momentum rallies. Everything is going up, it seems, and everybody is making money, so it's time to jump on board. Sentiment indicators, such as the American Association of Individual Investors survey, have been moving in a bullish direction since November. Last week's AAII survey was the seventh in eight weeks to show bullish sentiment over 40%. (The historical average is 39%.)
And while, from a long-term perspective, the time to buy is when this survey is bearish and the time to worry is when it is bullish, in the shorter term, numbers like these indicate an upward trend still in place.
The urge to jump in because stocks are rising can be an especially powerful fuel for a market rally when there's a lot of money that can move into stocks. That seems to be the case now as cash flows into equities have soared with a climbing stock market.
To cite one indicator: According to the Investment Company Institute, back in November investors took a net $23.2 billion out of mutual funds that invest in stocks. That was up from an outflow of $16.4 billion in October and continued a pattern (which had held for much of 2012) of money flowing out of stock funds. Those outflows slowed in December and reversed in January.
For example, in the week that ended on Jan. 16, $9.32 billion flowed into equity mutual funds. That followed inflows of $14.3 billion into equity funds for the week before. The money flowing into equity funds seems to be coming from the sidelines, where it was in cash or cash equivalents, or from bonds and bond funds.
When stocks are going up, investors want to put more money into stocks. That's a pretty good description of a momentum market.
The Big-Picture Mojo
But this is only one of two kinds of momentum at work right now.
I call the second kind macro momentum. It goes like this: If stocks were moving up when we were all afraid of the collapse of the euro, the US fiscal cliff and a paralyzing fight over raising the US debt ceiling, doesn't it follow that stocks should move even higher now that we're no longer afraid of those things? Particularly when we've also seen, moves from the Bank of Japan and the Federal Reserve that support the prices of financial assets?
You can think of this kind of momentum as equivalent to an extended relief rally. If you were reluctant to put money into stocks with the fiscal cliff looming, well, that's no longer a risk. Nor is the debt ceiling, at least not immediately. The Eurozone crisis is on a back burner as well. China's economy isn't headed for a hard landing. Japan is going to try to stimulate its way out of another recession.
Suddenly, what's to worry about?
I can make a case that all this absence of worry is already priced in and that growth of the gross domestic product and earnings don't support a move higher from here. Didn't the World Bank just cut its growth projections for 2013 for pretty much every economy from the United States to China? (That's a rhetorical question. Yes, it did.)
And isn't earnings growth looking kind of anemic? On Dec. 31, the projected earnings-growth rate for the S&P 500 stocks from Wall Street analysts was just 2.6%. That follows on a drop in S&P 500 earnings of 3.6% in the third quarter of 2012.
But that's looking back. What counts now is projected earnings for 2013. The Wall Street consensus on S&P 500 earnings for 2013 as of the beginning of January was $113.88. (That would be earnings growth of somewhere between 10% and 13% for the year, depending on where earnings for the S&P 500 in 2012 come out when the fourth quarter is completely in the book.) That would put the forward projected price-to-earnings ratio at 13.13 on Wednesday's closing price on the S&P 500. That's slightly above the five-year average forward price-to-earnings ratio of 12.8, but not so far above that that its flashes a red light to momentum investors (who don't want to see warning signs anyway).
Adding all this up, I see a momentum market where the momentum could run for a while-until, say, the next round of the debt ceiling battle in April, or a return of the Eurozone debt crisis in June, or evidence of faltering growth in the United States and a deeper-than-projected recession in the Eurozone at the end of the second quarter. (I think the projections of S&P 500 earnings for 2013 will turn out to be too high.)
That creates a quandry that's all too familiar to investors from the volatile markets of 2011 and 2012. How do you stay in the market to profit from the momentum without losing touch with fundamentals so that you wind up with big losses when the momentum stops?