Inside the Markets Recent Drop
- Jun 09, 2006
- admin
- Investing
For those of you who have been surprised about the market’s recent drop, I’d like to share with you a direct excerpt I wrote to members of Fallen Angel Stocks in the April issue.
When I wrote it the market was over 1,000 points higher then it is today and the front page of Barrons the following week proclaimed that many of its fund managers were predicting the market to go over 12,000. Everybody was as bullish as I’ve seen in some time.
As you might have guessed by now, I predicted the market was going to drop. But I am not writing today to brag or say “I told you so.” To be brutally frank with you, my own sense of self-worth has little to do with the opinion of other people.
Instead, I have two specific reasons to share this with you:
The first is to remind you not to lose perspective and get nervous about it. As I explain below, what’s happening is simply a paradigm shift as the markets finally begin to “price in” increased interest rates and other risks.
The other reason is because, unlike many competing financial advisory services, we take our obligation to share our experience with our readers very seriously. I’m not saying that our competitors don’t take their obligations seriously. What I am saying is that many just don’t have the experience or even capacity to break it down like this. That’s what separates us from 99% of our competitors.
(Please note: Keep in mind that this was written in April)
“The stock market’s rise has reflected the underlying health of a great economy. But as we all know, economies move in cycles. We are currently at the peak of this one.
What does that mean?
As I explained in my economic article, I don’t think that the spike in energy prices will derail the economy. However, I do firmly believe we’re at the top of an economic cycle.
For starters, it means that in the mid-term, the stock market has no place else to go but down.
Sure, it may trade higher or lower by a few hundred points here and there but there isn’t one good reason why the market should trade higher…all the good news is already priced in.
Yes, I think the market as a whole has no place else to go but down. It’s not a question of “if” it’s a question of “when.”
Many of you recall that I place absolutely zero faith in predictions from market “experts.” That has not changed.
Theoretically, the market could go as high as the ignorance or optimism of people investing in it. Heck, if everybody believes that the Dow Jones Industrial Average is worth 20,000, then sure enough it will trade there in the short-term.
However, history doesn’t suggest that this will happen with this market.
Unlike the heyday of the Internet bubble years, there isn’t a “new paradigm” shift taking place.
Yes, some people argue that both China and India’s emergence into the world stage amounts to a new paradigm. But nothing could be further from the truth…
The world has seen the rise of many great nations over the past century alone and each and every single one has been marked by multiple boom and bust cycles.
Commodity-starved Japan went from nowhere to become the 2nd largest economy in the world from 1970 to 1990 and that didn’t change the long-held laws of economics. In the face of tremendous growth in buying power for Japan, the world still continued to experience bull and bear markets with regularity.
Why would China’s emergence as a world economic power be any different?
Dear members of Fallen Angel Stocks heed my words when I say, it won’t be different.
Why the Stock Market is Overvalued
Contrary to popular belief, the stock markets recent run has been powered by cyclical economic factors that have reached their peak.
Now the length of the peak – whether it be weeks, months or quarters – may be in dispute. But the fact that it has reached is peak isn’t – there’s over 1,000 years of economic history to back it up. Let me offer another example.
Let’s say that the entire world consisted of the town called “Cheap Moneyville,” population 1,000.
Now let’s say that in your town you could borrow money really cheaply, almost at unheard-of levels. All that borrowed money created new factories which led to strong job creation.
To top it off, the easy access to cheap money led home prices to skyrocket.
This made people believe that they had more then they really did which spurred even greater spending.
But everybody is making so much that they all want to purchase the same finite amount of resources such as corn and milk. Suddenly, prices on many products began to rise.
To fight the rise in prices – inflation – your town begins to raise interest rates. The cheap money that was fueling economic growth is now replaced by more expensive money.
As a country we are in the last paragraph, economically speaking. That’s why I wrote my article suggesting that the economy looks fine right now.
But as investors we can’t profit from today’s news. The big money is made from tomorrow’s news.
So now let me finish the last paragraph:
Suddenly, the rise in interest rates and gas prices combine to reduce consumer spending. Since this economy is 2/3 powered by consumer spending, economic growth begins to slow.
The above is happening right now as we speak.
Does this conflict in any way, shape or form with the economic article I wrote this month? Not in the least. The economy is doing fine because it is at the top of a cycle. In all likelihood, it will continue to do fine through the summer, but it pays to be prudent now.
Remember, the stock market is at a cyclical high based on yesterday’s and today’s economic news.
But the stock market is an anticipatory vehicle. It prices are based on what it thinks will happen in the future….and the future, based on the nature of economic cycles, will simply not be as rosy as it is now.
How You Can Protect Yourself from Suffering Huge Stock Losses
When you signed up for our service you received a free report entitled, “5 Rules to Profit from in 2006.” I strongly urge you to re-read it. (If you need another copy feel free to write me and I’ll shoot it over to you).
Many of my peers would probably choose not to share these rules with you until the stock market was actually in the middle of a bad time, but as far as I’m concerned, that’s just poor planning.
What good is valuable information if it’s a day late and a dollar short?
Feel free to call me paranoid: Both experience and history have taught me (often the hard way) that a fool and his money are lucky enough to get together in the first place.
Having lived through some of the worst markets imaginable – and having made money in them – I want you to know that it is possible to do so. The trick is to limit your exposure to weaker companies and bet big when you have the chance to do so with stronger ones.
That’s why I sold three positions which were in the model portfolio this month: American Eagle Outfitters (SYM: AEOS), Armor Holdings (SYM: AH) and Oxford Industries (SYM: OXM).
In the case of the first two, we purchased them at the end of January and saw fast profits of 20% and 29% respectively. I felt that while they continued to be great companies, they’re overextended and in a weak market, those are the first to go.
My reason for selling Oxford Industries was a bit more basic. Several weeks ago, I heard from a well-placed friend that there was a huge seller of stock that wanted to get out. When I saw the stock try to break to the upside, it seemed that it never could. Once again, in a weak market this type of company is vulnerable.
How You Can Make Money in this Market…
Unfortunately, for that piece of the article you’ll have to become a member of Fallen Angel Stocks.
Fortunately, that could be one of the best investments you’ll make all year.
— By Dylan P. Jovine