Stock charts are built from data generated by the true ACTIONS of investors. Until someone buys or sells a stock, the stock price does not change. And, of course, the charts could care less what reason the investors had for their action and care even less what the most authoritative source has recently said in their latest article (might be stepping on my own toes here a bit, I guess). All the chart sees is ACTION — all it reflects is the sum total of ALL the investors decisions to buy or sell.
Now, consider the action of the Dow since July 25, 2006. On July 25, it closed at 11,003. From that date, it went to a high of 12,786 on February 20, 2007 — an increase of 1,783 points, a gain of nearly 17 percent in just 7 months!
Now, consider this: The Federal Reserve discount rate had just been raised in late June 2006 to 5.25 percent, the last of a series of 17 hikes that began in June 2004 when the discount rate was 1 percent! Yet the DOW could have cared less about the tighter rates. It just turned up its nose to the rate hike and rose to an unprecedented new high! Why? Simple. There were more buyers than sellers.
Look, I don't want you to think I am playing games with words, here. My point is this. If you have ever been to an auction, the bidding for the also-ran stuff is usually quietly lame to downright boring. But, the stuff the buyers really want to buy always — I repeat, always — brings them to life — and in droves! Why the difference? Again, simple. They want the good stuff and they are willing to pay for it!
So, like the auction bidders, stock market investors buy when they believe they see a good opportunity. And by July 25, 2006 they saw one — obviously. The numbers PROVE it. Let me repeat, the numbers PROVE it! And you can't change the reality of the numbers.
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So today when I look at my Super Chart, I see that huge rally traced out very clearly. But, I also see it was followed by the recent selling. Is that selling cause for concern? Hardly. Buyers are prone to lock in profits from time to time and after the huge 1,783 point rise, they did it again. Fair enough. Profits are the name of the game. God bless them that took their profits.
But, I also see something else even more clearly. Only about 30-35 percent of the huge gain was retraced (see the chart below). That tells me only about 3 in 10 investors have taken their profits. What do the other 7 know that keeps them in the game? I say it is the expectation of much higher stock prices still to come. Simple as that. The opportunity is still there! Charts don't lie and they don't write articles. They just point the way to the future!
I attribute the decision of the other 7 to the Federal Reserve. More specifically, I put the blame on Dr. Ben - Dr. Benjamin Bernanke, the Fed Chairman. He is now clearly in charge of the Federal Reserve's activities. It took a year or so from the time he took charge to do it, but his people and his philosophy are taking charge of our future. The Greenspan years are over. And the Super Chart tells me that Dr. Ben's actions have set us up for another big rally.
Don't believe me? Well, I would refer you to Dr. Ben's book, published in 2000, called "Essays on the Great Depression." In it are essays he wrote over about a 15-16 year period. They are a road map to our future. If you read these essays, you will see that Dr. Ben firmly believes that deflation is the number one economic growth killer, not interest rates. Further, and most important, he believes that a too small or a contracting money supply chokes growth absolutely – not interest rates!! This is a total 180 degree turn from the Greenspan philosophy.
Dr. Ben believes that economic expansions do not have to die and/or be followed by recessions. He believes that the real estate deflation of 1927 is what set off the 1929 crash. He writes that had the 1927 real estate deflation been properly addressed; there would have been NO 1929 CRASH! Take care of real estate and the economy will hold its own, he says in so many words. And folks, what he believes is about to either make you rich or make you just a spectator to the coming boom. Read his book! It is all right there.
Sounds pretty revolutionary! It is certainly not the rules that have been followed since 1913 when the Fed was created by an act of Congress. It is, in my opinion, why Dr Ben and Mr. Greenspan are disagreeing, in public by the way, about whether or not the present economy is or is not headed for a recession.
But, back to the Super Chart. I said in my article about the Feb. 27 decline, that if we held the 1375 level on the S&P (cash basis) and recovered more than 60 percent of the decline seen on the 27th, we were headed for much higher ground in the averages (see MoneyNews Experts' Corner to read that entire article from the archives). Well, we did hold the 1375 level and we have recovered well over 60 percent of the recent decline. Incredible action!
Now, add in this action, the action by Dr. Ben. The money supply is rising at the rate of nearly $800-900 billion a year, a huge, huge number. Dr. Ben is feeding a rally, not a recession. He is addressing the 2007 real estate problem not addressed in 1927, with a huge pile of money to keep real estate sales going. So, while Dr. Ben is talking about fighting inflation (and to a point, he is very serious), his actions say he wants GROWTH in this economy - BIG GROWTH!! Actions ALWAYS speak louder than words. Forget all the talk about interest rates. THAT IS NOT WHERE THE ACTION IS!! Watch the money supply growth!!
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So? Who are you going to listen to, Dr. Ben or all the other noise out there? I say it better be Dr. Ben and his fast growing money supply. Believe me, Dr. Ben is a man of his beliefs. He is voting for growth! Better be a buyer in here, folks — a buyer!
And to answer that question from the back of the room, yes there are events that would make me eat my words (none of them interest rate changes, by the way). If the S&P dropped below the current 1307 S&P level (cash basis), at my Super Chart "keyline" (see chart below), or there were some catastrophic financial meltdown that occurred (and there is NO indication that any such meltdown is even on the far horizon), yes, that would change my mind. Otherwise, be a buyer!
My target you ask? Well, about 1520-1540 on the cash S&P, maybe about 800-1000 points on the Dow from here (roughly a target of 13,500 to 13,700). I will know the rally is in full swing when we break above the S&P 1455 old high and hold above it for a few weeks. Can we go higher than my target? Sure. But, let the charts tell us where we are headed when we hit our initial target.
Now, before I close up for the day, let me add a little study session in here. With a big rally about to unfold, how do you build a "safe" portfolio? The four rules below are what I call my "universal" rules. They are important to observe in any trading environment. I suggest you read them carefully and see how your current income investing activities measure up against them. I believe if you use them consistently, not only will you make money in the coming rally, but will know when to take profits and how to protect your portfolio equity better than 90 percent of the investors out there.
That said, let's talk about the Four Rules in detail.
Rule #1: Your age should dictate how much risk you should take in your portfolio. It is ALWAYS a question of risk-taking. Stocks are mainly for growth of equity and bonds are generally for income and safety of principal. Therefore, the first look at your portfolio should always be the balance in your portfolio between stocks and bonds. To put it in very simple terms, a higher percentage of stock investments means more risk to equity, a higher percentage of bond investments means less risk to equity.
Several weeks ago, I gave you a very good guide to age and portfolio risk levels you should follow when building your portfolio. The title of the article was "Two Rules for Income Investing." Let me repeat a prime rule from that article. Don't ever put all or even a very large part of your investments solely in, let's say, stocks representing technology, or international stocks, or health-care stocks, etc. Why? If these areas get hit by massive selling, your portfolio will also be hit by massive equity losses. A good example of this was the 2000-2001 sell-off in the technology stocks. Many investors lost very large parts of their equity from not following this rule. Your lesson from that event should be to view history as most valuable teacher.
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Rule #2: Having decided to have a mix of stocks and bonds in your portfolio, let us focus first on the stocks portion. Your stock investments should represent a minimum of 7-8 industry sectors. What is a sector? Well, for example, health-care, transportation, food, retail, technology, insurance, etc. A good place to find a more complete list is to go to any one of a number of web sites that pop up when you use a search engine with the words "stock sectors." Then, use these five points as your guides:
1. Try and select sectors with which you are familiar. These may be ones allied with the business you are in, or industries that are the dominate employers in your area, or even industries you often use, such as healthcare or food.
2. Select sectors that include some very large companies with a long history. These large companies are ideal as foundations in your portfolio for a long term investment strategy of growth and income from dividends.
3. Try and keep away from using two closely similar type sectors in your portfolio, such as drugs and healthcare stocks, for example.
4. After selecting the sectors in which you want to invest, select one company from each sector as your final stock selection. These stocks should make up 75 percent of your total stock investments. Once each year, or in stock sell-offs that you consider unusual, review the stock selection you have made to be sure the growth and dividend histories remain as stable as possible and that the industry remains a good investment. If adjustments seem warranted, make them. Keep your portfolio abreast of the times. Remember, buggy whips were great in 1890, but not in 1920.
5. The 25 percent balance of your investments in the stock portion should be made up of no-load mutual funds. Invest in funds that have a long history of growth in good times and a minimum of decline when stock markets have declined. Sectors are not the prime considerations here. We are interested in mutual funds that have good, long histories. These act as a back-up cushion in down markets and the fund managers do all the work of yearly and emergency review for you.
Rule #3: The bond portion of your portfolio should represent only BA rated bonds or better when you are under 50 and only A rated or better when you are over 50 years of age. Ratings are maintained on all bonds ever issued, so your broker can provide you the exact rating when you purchase the bond. Here, also, check once each year to be sure that your bond rating is stable. If it falls below the appropriate level, sell the bond and reinvest in better rated bonds.
Bond all have "maturity" dates, that is, the date the bond loan is paid back in cash to the holder of the bond. Generally, you should invest in 10-year bonds before age 50 and 5-10 year bonds if you are over 50. When you reach age 60-62, consider moving to all Treasury bonds (the safest bond investment) for your portfolio and continue to apply the 5-10 year rule here, as well.
As for interest rates, you will be somewhat constrained by the prevailing bond rates at the time you buy your bonds, but shop around for the best interest rate available And also shop around for the lowest commission and fee rates that brokers will offer. Be wary if the interest rate offered is above the generally prevailing rates available, as this is often a warning sign that the issue may be suffering some sort of problem. This applies to all but the Treasury issues, of course.
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Rule #4: Do all your own analysis and all your own purchasing of stocks and bonds. There is nothing like begin involved at the "grass-roots" level of analysis and purchasing of your portfolio holdings to give you control and that sense of well being when it comes to your portfolio's health. In good market times you will benefit from knowing you have made good choices for your portfolio. And in down market times, it will be a major comfort that you have a portfolio that, while it may suffer a bit, won't fall apart and leave you with huge losses.
Now, if you feel the need to hire a consultant to help you, I have no quarrel with this at all. BUT — never let any consultant do your buying of stocks or bonds. If you hire a consultant, ask for written analysis of why he recommends a specific stock or bond, but ALWAYS make the purchase yourself and ask questions of the broker when you do. Is the broker allied to the consultant in any way? Does the consultant get any commission from the fact that you are buying the stock or bond from the broker? Is there any current broker analyst report on the stock or bond you are about to buy? If so, get a copy before you make the purchase and study it for yourself. BE INVOLVED!! BE ALERT!! When retirement comes, having been involved will give you a good grasp of what to do in the retirement years to maintain the good health of your portfolio.
Well, that's it for this week. Do hope your coming investment week is a good one. In the meantime, you keep in touch. I do. See you next week.
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