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2 Questions To Ask Yourself If You’re Worried About Your Investments Right Now

“An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative.” -Benjamin Graham, The Intelligent Investor

Are you concerned about the markets right now? Do you worry about how your investments might fair in a prolonged decline? If so, I encourage you to think them in terms of that quote above.

According to Ben Graham, Warren Buffett’s teacher at Columbia Business School, an investment must meet two simple criteria:

  • First, does it offer safety of principal? In other words, ‘is my initial investment protected somehow such that I’m likely to get it back even if my analysis is faulty?’
  • Second, will it provide an adequate return? In other words, ‘am I being adequately compensated for the risk I’m taking here?’

If you can honestly answer both of these questions with a confident ‘yes’ then you should have no worries.

If you answer either of these with a ‘no’ then you should probably have some sort of stop loss (like the primary trend) in place to make sure you don’t let a speculative position hurt you too badly if it goes against you.

Finally, if you don’t know where to begin in answering these questions then you’re clearly operating outside your own “circle of competence.”

In this case, you probably want to educate yourself a bit more so that you understand how to answer these questions and then focus your efforts going forward on investments that are within your own ability to analyze.

And why not start right where Buffett did with, “The Intelligent Investor“?

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Is It Time To Buy Stocks? Not If You’re A Long-Term Investor

The stock market is off to its worst start in history this year. Not only that, the losses over the past few weeks have come amid one of the most rapid declines over the past few decades. This has some coming to the conclusion this has to be buying opportunity.

I’ve seen plenty of headlines and articles lately featuring advisors suggesting investors ‘stay the course’ or even ‘buy into the depressed prices.’ But is this really good advice for the average investor?

There are a couple of questions to be answered here. First, how ‘depressed’ are prices? Are stocks actually cheap? I think most investors would be shocked to find out that, not only are stocks not yet cheap, they are, in fact, still very expensive.

Using Warren Buffett’s measure of total market cap-to-GDP, stocks are still well above their long-term average valuation even after the declines we have seen recently. In fact, the only time they were more expensive than today, even after the recent selloff, was during the height of the dotcom bubble in 1999-2000.

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Furthermore, “well above fair value,” carries a couple of unpleasant implications. First, it means returns going forward are going to be well below average. “The price you pay determines your rate of return.” Pay a high price and you are guaranteed a low rate of return.

The chart below shows the expected rate of return from current valuations compared to the yield on the 10-year treasury note. Right now investors are taking much greater risk for less return than can be gained from the “risk-free” rate. This makes it hard to justify stocks as an, “investment,” currently.

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Second, paying well above average valuations means you expose yourself to above average risks. If stocks fell back to their long-term average valuation based on this measure, it would mean about a 40% decline from current levels. For valuations to actually become ‘depressed,’ it would take an even greater decline. And the history of valuations and drawdowns validates this risk.

So simply based upon valuations it’s not a great time to buy stocks. However, Warren Buffett has also famously advised investors to, ‘be greedy when others are fearful.’ Have investors become unduly fearful which would mean it’s time to get greedy?

In the short-term, one could argue we are seeing a certain amount of fear in the markets. CNN’s fear and greed model recently got pretty low. DSI, another sentiment indicator, also shows investors have become pretty bearish recently.

DSIChart via Nautilus

It’s very important to note, however, that these are very short-term indicators. For this reason, they are probably only appropriate for short-term traders. On a long-term time horizon, we are only just now coming off of one of the extended periods of bullish euphoria in history for the stock market. Is a bit of short-term fear enough to form a long-term bottom?Screen Shot 2016-01-21 at 9.28.20 AMChart via Yardeni

One way to look at longer-term investor sentiment is to observe the total amount of leveraged speculation in the markets relative to the overall economy (as measured by margin debt-to-GDP). When leveraged speculation is very high, investors can reliably be considered greedy and vice versa.

Currently, the amount of leveraged speculation relative to the economy is about as high as it was just prior to the dotcom bust and the financial crisis. In other words, very rarely have investors ever been more greedy than they are today, which should remind you of the other half of Buffett’s advice: ‘be fearful when others are greedy.’

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All in all, it’s difficult to make the case it’s time to buy stocks today for anyone other than a very short-term trader. They remain very highly valued and investors have not become fearful yet on a long-term time frame by any stretch of the imagination.

These are two of the reasons I have been recommending investors consider reducing risk in their portfolios over the past year or so. If you’re a long-term investor, it’s still not a great time to buy. Considering the poor returns and elevated risks stocks pose currently, you may want to do just the opposite in order to match your risk tolerance and time frame to this reality.

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5 Different Technical Tools For Traders In One Chart

Last fall I wrote a post titled, “This Is Now The Worst Possible Environment For Stock Market Investors.” My point then was that stocks were very expensive, sentiment was exuberant and the trend had shifted to the downside. In other words, all three of the major components of my investing strategy were bearish.

None of this his has changed (though stocks may bounce after the persistent selling we have seen recently). But, in that post, I shared a version of the chart above which became fairly popular so I thought I’d explain what’s going on it and the individual components noted in it.

First, the horizontal blue lines show a Fibonacci target for the S&P 500 at 2138 (2015’s high was 2134.72 on May 18). This target is calculated simply by projecting a 61.8% (the Fibonacci Ratio) extension of the bull market gains from 2009 to 2013, the point at which we finally broke above the old 2007 high. (Apple reached a similar target about a year ago which was a decent sell signal, as well.)

The vertical blue lines simply measure the time between major peaks. The span from the March 2000 peak to the October 2007 peak was seven years and seven months. Seven years and seven months from October 2007 was May 2015, the exact month the S&P 500 peaked last year.

I’ve also highlighted the momentum divergences on the chart. While prices made higher highs in March of 2000 and October of 2007, RSI was making lower highs, suggesting momentum was waning. The MACD crosses at the bottom of the chart were also decent sell signals on those occasions. Both occurred again last year in very similar fashion to those prior occurrences.

The “9” and “13” on the chart are DeMark Sequential signals. The 9 signifies a completed sell setup and the 13 is the completed sell signal. These are essentially the inverse of the buy signals I highlighted in March of 2009. (I also used these as part of my sell signal in Apple.)

Finally, I have included a 10-month moving average on the chart, roughly equivalent to the 200-day moving average. This may be the easiest signal for individual investors to monitor. It’s also Paul Tudor Jones single most important indicator. When prices close above this average, stocks are in an uptrend. Below and stocks are in a downtrend.

Do these things work on their own merit or do they work because so many traders watch and use them? That’s the age-old question posed regarding technical analysis. However, it’s fairly plain to see that simply paying attention to the overall trend can make a massive difference in your investing success by keeping you on the right side of the market. If it’s good enough for Paul Tudor Jones, it’s good enough for me.

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Like Clockwork They’re Bashing Buffett Again

Once again, it’s becoming popular for the media to bash Warren Buffett’s lackluster performance.

If you’ve not been hiding under a rock for the past few months, though, you’re well aware of the fact that there are just a handful of stocks responsible for the gains in the major indexes this year. Outside of these few, the vast majority of stocks have actually declined in 2015.

Certainly, Warren is not the sort of investor to buy the FANGs. Facebook, Amazon, Netflix and Google trade at an average p/e of 360 making them entirely off-limits to any self-respecting value investor.

This is no revelation. What is interesting, however, is every time the media sees fit to bash Buffett in this way, he ends up getting the last laugh.

They bashed him during the financial crisis for being too bullish. The big, bullish bets he put on back in 2008 and 2009, though, have paid off incredibly well since then.

And, in a more similar fashion to today’s bashing, the media tarred and feathered Warren back in 1999 for being, “out of touch,” in sitting out the dotcom boom. In a cover story, Barron’s wrote:

To be blunt, Buffett, who turns 70 in 2000, is viewed by an increasing number of investors as too conservative, even passe. Buffett, Berkshire’s chairman and chief executive, may be the world’s greatest investor, but he hasn’t anticipated or capitalized on the boom in technology stocks in the past few years.

This ran in December, 1999, just a few months before the boom famously turned to bust. Once again, Warren hasn’t, “anticipated or capitalized on the boom in technology stocks,” and his performance has suffered as a result.

But, after successfully practicing his own brand of investing for over half a century, do you think he’s worried about his short-term underperformance? Or worried about them teasing him about it?

I’d actually be surprised if he didn’t see this sort of criticism in the media as a contrary indicator and marvel at its cyclical regularity.

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Margin Debt-to-GDP Rises Back To The Level Of Prior Bull Market Peaks

Margin debt made a comeback in October. With stocks rising 10% or so during the month this should not be surprising at all.

What is interesting, however, is the level of margin debt-to-GDP. As I’ve written many times before, I prefer this measure because it’s been highly correlated to forward 3-year returns in stocks for the past couple of decades.

With October’s gain of nearly $20 billion, margin debt-to-GDP has now risen back to 2.64%. This is equal to the level it achieved at the peak of the last major bull market, in July 2007. Before this, the only other month it ever got this high was February of 2000, just prior to the peak of the dotcom bubble. In other words, this is pretty rarified air.

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To me, this simply suggests potential demand for stocks from this point is very limited (how much more can speculators borrow?) while potential supply is substantial (what happens when they decide it’s time to pay back these loans?).

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