Buy Signals to Watch for in 2014

12/26/2013 6:00 am EST

Focus: STOCKS

It’s never too early to start putting together your game plan for the new year, says David Moenning of StateoftheMarkets.com, as he details what you should watch for to succeed in the market in 2014.

To be sure, the Fed's decision to begin tapering their QE program remains the topic of conversation around water coolers in Manhattan, Chicago and LA. In short, nobody really expected Ben Bernanke to start cutting back on one of his greatest inventions as he moved toward the door. However, at the same time, it is a safe bet that very few analysts expected the combination of a taper, an extension of the Fed's zero interest rate policy, and an increased focus on inflation. Wow.

But now that the Fed is out of the way for a while and the market did not go throw another “taper tantrum,” it's time to get back to the idea of planning 2014's investing strategy.

Thus far, we've discussed the following ideas:

  • 2013 was a very unique year in that the US stock market was the only place to be

  • Investors learned about "diworsification" this year

  • Individual and professional investors alike were largely underwhelmed by their returns in 2013

  • The term “gain regret” is back in a big way at financial planning firms

  • Planning for the market to “repeat” its 2013 performance is probably a bad (very bad) idea

  • It is a good idea to have a plan for how you are going to try and stay on the right side of the market in the coming year

  • The historical cycles suggest that there could be a meaningful correction (a “mini” bear market, perhaps?)

  • The current bull market has produced gains that have been nearly double the historical average

  • The current bull is growing old

  • Valuations are no longer “cheap” and are either “fair” or slightly overvalued

  • Thus, keeping a couple big-picture, easy-to-use sell signals at your side makes sense

A Sell Off Might Be Waiting in Wings
In sum, some very well-respected analysts expect to see the bears come out of hibernation at some point next year. And despite the DJIA and S&P sitting at or near all-time highs, our market models are not exactly singing a happy song right now. No, the bottom line is the divergence between some of our indicators and the price action in the major indices is worrisome.

This fact alone is a good reason to make sure you enter 2014 with your risk-management tool belt strapped on. Remember, the last correction of more than 5% was more than a year ago. And history shows that the type of one-way street we've seen in stocks this year doesn't last forever.

But, You Might Need a Buy Signal or Two as Well in 2014
So, let's assume that you enter the New Year on your toes. You are ready to defend against the next bear raid on your portfolio and you get out of the way when the decline hits. The question then becomes: will you know how to get back in?

NEXT PAGE: Signals to “Buy ‘Em!”

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Remember, without a new crisis or some horrible external event, analysts are not looking for a brutal bear market. Therefore, just “selling in May and going away” isn't likely to be a winning approach.

No sir. If you expect to succeed in 2014, you will likely need to execute on the buy side as well.

Signals to “Buy ‘Em!”
Frankly, there are lots of great buy signals. For example, you could “be like Buffett” and buy when there is “blood in the streets.”

In English, this means that you should buy when stocks are down 10%. Then you should plan to buy some more if the indices fall 15%. And then go ahead and add another batch of capital if the S&P manages to decline by 20%.

Please understand that you are not likely to get the bottom of the bear move using such an approach. But, using this “legging in” strategy will cause you to “buy low.” And in the long run, the shares you purchase when things look ugly will help you outperform when the bulls return.

Another strategy that folks tend to like is the “golden cross.” The idea is to buy when the 50-day moving average crosses above the 200-day moving average. This is clearly a VERY long-term approach, but the historical results are pretty decent and this signal will get you back on the bull bandwagon before things get away from you.

Trust The Thrust!
However, one of the best longer-term buy signals is called a “breadth thrust.” Cutting to the chase, it usually pays to, in the words of Ned Davis Research, “trust the thrust.”

The buy signal occurs when the percentage of stocks above their 50-day moving averages has first been below 75% and then moves above 90%.

The reading indicates that the 90% of stocks are healthy from a technical perspective and that the market is “surging.” And history shows that this is an indicator to watch.

Since 1967, there have been 17 “breadth thrust” buy signals. Although the signals have been more frequent since 2007, the profitability of the signals is still strong. You see, the S&P 500 has been higher 82.3% of the time one month after the signal occurs. And the market's average gain one month out has been 3.1% (compared to the average of 0.6% for all one-month periods).

The beauty here is that the signal results are stronger the farther out you go. Three months later, stocks are up 94% of the time and sport an average gain of 6.1% versus 1.9 for all three-month periods. Same thing six months later - 94% of the signals are profitable and the average gain is 11.1% versus 3.9%. And one year later, ALL of the signals produced gains, with the average gain being 16.7% as opposed to all one-year period gains since 1967 of 7.9%.

Thus, history shows this is a signal it pays to heed. Oh, and the last signal occurred on January 4, 2013. So it would have helped investors get on board what turned out to be a very strong run.

By David Moenning of StateoftheMarkets.com

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