Are Conditions Right for a Rally?

10/21/2011 7:00 am EST


Over more than 40 years, Don Hays has developed a system that tracks psychological, monetary, and valuation indicators to determine the market’s probable direction. As occurred in the early 1980s, following years of market malaise, he again sees indicators aligning to suggest a positive trend could be ahead.

Kate Stalter: I’m on the phone today with Don Hays of Hays Advisory. Don, you use a number of different models and indicators to analyze the market, but your overall approach is to move into stocks when you see less overall risk.

So what’s your bias at this juncture, and what do you advise the do-it-yourself investors to do?

Don Hays: Well, thank you, Kate. That’s exactly right: We’re very much a top-down investor, and we’ve been doing this for 40 years. Typically, we find that’s the only way for people to successfully invest over the years.

Now what that means is, of course, as you become more aggressive and less aggressive, depending upon what the indicators are showing—now when I say indicators, it sounds sort of like a crystal ball—but the truth of the matter is, it’s very much fundamental.

We use three different characteristics of the market, and they all are very dependent upon each other: Psychology, monetary conditions, and valuation of the market.

Now I guess you would say the backbone of this is psychology, because psychology, when people get very, very optimistic, you know the Federal Reserve is going to be taking the punchbowl away. They’re going to start tightening monetary liquidity. So very much optimism says monetary liquidity gets more negative.

Now when people are very, very optimistic, the market gets overvalued, and so valuation also tells you that the market is less aggressive, less attractive at that moment, and the vice versa works.

So right now, what we’re looking at are three characteristics. We’re looking at the headlines, of course, but the truth is, the crux of our investment strategy is based on those characteristics, and it just virtually never fails to call the market.

So if you look at psychology today, people are extremely nervous. In those kind of times, Warren Buffett tells us, when other people get pessimistic, you get greedy. And that’s exactly what that’s saying today. Very optimistic. It’s what we call P1 on a scale of 1 to 6, 1 being the most attractive.

Now that turns us to monetary. If you’re looking at monetary liquidity, again, we have a scale of 1 to 6 and we’re saying M1, as optimistic as you can get, extreme liquidity in the market.

Everybody knows about this, but they don’t trust it and they never do. They don’t trust it as the bottom…but it’s saying the Federal Reserve is pouring all the fuel into the system that the system will take.

The third characteristic is valuation. And again, I hate to be boring, but valuation is extremely undervalued—about as optimistic as you can get on the future.

Now all three items have been in sync here for just a few weeks. That does not mean the market just turned positive. It has been positive for about two months here—very positive—but we think today is one of the most optimistic times you can get for long-term investors.


Kate Stalter: You had a blog post the other day where you showed that famous old “BusinessWeek” cover, asking, “Are equities dead?” And you brought that up in the context of your belief that there is more upside to follow after the March 2009 market bottom, but that people really don’t believe that.

Don Hays: We really like that observation, because it was somewhat early in my career. But by the same token, in 1982, we looked at the Dow Jones industrial average, and I had 13 years with the Dow Jones going nowhere. It was all under 1,000 and it would back and flow, up and down, up and down.

Today, if you look at the Dow Jones Industrial Average just a few weeks ago, we have had 13 years with absolutely no progress, exactly even. So there’s some similarity to that.

Now, of course, everybody’s pessimistic, but when you look at what causes a bright future, it’s when people take the steps to cure problems. You only cure problems when you’ve been spanked, when you’ve been disciplined.

So what we have, we have a Congress that’s been disciplined, we have a president that’s been disciplined, we have corporate leaders who are getting disciplined and we’re seeing investors—everybody is disciplined. So when you see, they’re going to learn a lesson. It’s not obvious yet, but you’re going to see it.

We think actually the supercommittee may be one of the things that lights the fuse for this market.

But you’re going to see—the supercommittee is going to come out with a non-biased plan, not Republican, not Democrat, both sides of the aisle. We think it’s going to be a positive statement they come out with, right before Thanksgiving.

Kate Stalter: Looking forward to that, then. That’s something very optimistic, that I’m sure our listeners will like to hear.

Don, let me ask you this: You’ve also written about sector strength quite a bit. Let’s talk a little bit about some of the sectors that you do see as showing signs of outperformance, and maybe some of the individual stocks that you see as being leaders right now.

Don Hays: Well, that is a very interesting part of this, and we’ve been in something: The technology revolution. Everybody certainly observes that now. But it started coming out from under cover, escaping from the cocoon, in about 1994, or 1995, and we reached that massive turbulence phase in 2000, and you saw technology stocks really get clobbered in 2000 to 2003.

It’s what happens a lot of times when somebody’s had an extreme shock. You go through a period of time to allow the bruises to heal, and we think that’s been happening since about 2003 and you’ve seen that in many stocks like Microsoft (MSFT), some of the major leaders of the stocks.

But right now, our sector studies are starting to show technology is really starting to emerge. Now when you’re looking at these, you don’t look at just the leaders, obviously. You look a little bit under the surface.

We like Oracle (ORCL) very much—now you have to recognize we own these stocks, so we have a vested interest, but we also believe they’re some of the best stocks in the market today. Oracle looks very attractive. We like Accenture (ACN) very much. We own Cognizant Technology Solutions (CTSH). And so those areas look attractive.

Now if you broaden that just a little bit, surprisingly, some of the consumer stocks are looking pretty good. Now, we don’t own McDonald’s (MCD), but you look at McDonald’s and you’ll see an amazing trend in that stock. We do own Dick’s Sporting Goods (DKS).

And you’ll see everybody’s looking at the consumer and saying, “They owe so much money and they’re in bad shape.” But the truth is, their monthly payments on their debt service today is where it was ten years ago. So they’ve made huge strides, and believe it or not, the consumer stocks are starting to look pretty good.

Kate Stalter: Any other sectors that may be worth a glance? Or is the case that you really you have to be judicious in what you select these days?

Don Hays: Well, you have to be a little judicious on health care, but when you’re looking at health care now, it has a great pattern of revenue strength over 30 years, but it does have a lot of volatility up and down.

It tends to be a more defensive industry, but at this time, many of these stocks look pretty good, and we think they should be purchased and held by long-term investors.

One of them we’re looking at is HealthSpring (HS). And there’s others in that area that we like—McKesson (MCK). Those are two areas that we think are attractive for the future.

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