Is The Bear In The Cage?

For the last few weeks we have seen the stock market averages going higher and higher each week yet the economic news is still very bad. Is this bear market coming to an end? Will the stock prices and mutual funds go back up to where they were?

It seems all the talking heads on TV and the talk radio guys are telling you that now is the time to buy because the market will be much higher next year. "You can't afford to not be in the market" is the cry. They have lots of reasons that sound good, but almost none of them will hold water upon close analysis.

The one thing that I hear is that the market is now "fairly valued". Now the S&P500 index has a P/E ratio (that's Price/Earnings) of around 32 that means it will take 32 years to get back your money based on what the company's stock is earning today. It doesn't take a rocket scientist to realize there are many other places to get a better return. There are many, many stocks with P/E ratios in the hundreds and others that have no earnings at all. That doesn't mean those stocks won't go up; it means they won't stay up once people realize they have no value other than anticipation. That is why the Nasdaq has declined 75% so far and it is still over priced.

The Wall Street mavens say that next year earnings will be much better so the price today is cheap compared to what it will be then so you better buy now. When you go back in time you will see that the average P/E for the S&P500 index has been 14 - 15 for many years. Could that mean that "this time it is different" or is the index over priced by 200%?

Forty percent of the advance in stock prices is due to directional movement of the market as a whole, 40% due to the strength of the sector that it is in and 20% due to the quality of the company itself. You see, just because it is a "good" company does not mean the stock will advance. Birds of a feather flock together so the "good" company must be in a strong sector that is advancing and then the whole market must be advancing also. When you have all 3 of these things going you have a good chance of making money.

Where are we today? You must step back to take a long view of the market indexes. The price action of the past few weeks cannot be counted as the market trend as a whole. Most market technical analysts say that the market is in a rally phase of a long term bear market and that the rally will halt and head down somewhere near the 200-day moving average that is currently at about 10,300 on the DOW.

Is the bear back in his cage? Has the bull market returned? It depends upon who you want to believe but whatever you do you should be protecting your capital with trailing stop-loss orders on your stocks and mental stops for your mutual funds. Even those with IRAs and 401Ks can move their money into a money market account should the market start down again.

Time will tell.

Al Thomas' book, "If It Doesn't Go Up, Don't Buy It!" has helped thousands of people make money and keep their profits with his simple 2-step method. Read the first chapter at http://www.mutualfundmagic.com and discover why he's the man that Wall Street does not want you to know.

Copyright 2005