The stock market moves cyclically. The market rises and falls with the business cycles and cannot be simply timed by getting in or getting out by a calendar. Business cycles can last anywhere from a few years to a decade or more.
Successful investors pay close attention to the cycles and adjust their holdings accordingly. For example, when the business cycle is at a low point investors will start moving into industrial stocks as they will provide the most upside an a recovery. Conversely, when the business cycle is flying high investors will start taking profits and will start building positions in more defensive stocks or even move out of the stock market and into bonds or cash.
Look around. Where are we now? This is not rocket science and is very obvious. How is business doing? How is the market? It looks like business is slowly recovering here in early 2011, but the market as a whole has jumped up drastically since its lows of 2009. I am making these observations by simply watching Squawk Box on CNBC every morning, reading a myriad of articles from The Wall Street Journal to CNN Money and all bloggers I can get my eyes on and a few earnings calls I listened in on with my largest holdings. What is most important is knowing not just where we are, but where we are going from here.
When I am worried about a market that feels “toppy” (a very high-brow investing term), I go have a drink. No, the cocktail doesn’t clear my mind so that I can see into the future. I am actually doing investment research. I am trying to see if the bartender will offer up any great stock tips.
Although they are wise, I know bartenders aren’t usually known for their investing prowess necessarily. In fact they will not even know how valuable their stock tips are. I want to know “who” is in interested in the market. If bartenders, retail sales people, my barber or any other “retail investors” (non-professional investors) are excited enough about the market and I can see dollar signs protruding from their eyes as they run off a list of “sure thing” stocks – the bull market is dead.
After I gladly accept all the stock picks from my informant, I will check some economic indicators to see how much time I have. Because the stock market and the business cycle don’t move at exactly the same time, I can watch for a hint of bad news to come out. Then more bad news. Then more bad than good. All those retail investors will freak out and sell – starting the market on its inevitable bear run.
The stock market is a leading indicator of the business cycle. In 2011 the stock market seems to be leading the business cycle greatly. Even though the market may be over-valued as a whole, we are on the right side of the business cycle to be in stocks. On a side note, with interest rates near zero and being on the recovery side of the business cycle, bonds are a bad place to be. You have to pay attention to everything going on around you to invest successfully. By the way, when I asked the bartender for his recommendations, he said he feels like I should put everything in a gin and tonic… so our portfolios are good.