Why the Stock Market is Like a Deer in the Headlights

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The daily debate between our office’s bulls and bears continues. Dr Alex Cowie, Greg Canavan, Dan Denning and Kris Sayce all agree and disagree with each other about where the stock market is headed.

The discussions and email chains are getting longer and longer. To be honest it’s getting old. The flyovers of the Melbourne Grand Prix’s acrobatics planes make for more interesting background noise.

The reason you shouldn’t listen to them is that they’re all wrong. And they’re all right too. The simple truth is that the stock market as a whole is going nowhere. It’s like a deer in the headlights. A few percent up, a few percent down. We’ll show you just how flat it’s really been below.

There are only three ways you can make money in a market like this:

  1. You can pick a specific part of the economy and punt big, like Dan Denning is doing on certain shale gas stocks;
  2. You can actively trade distributions like Slipstream Trader Murray Dawes; or
  3. You can get paid to wait by investing in dividend paying stocks.

What makes bear markets such a brilliant time to invest is that you have such an interesting choice of strategies. Every type of personality and investment mentality is represented in those three choices.

Strategic thinkers like making targeted bets. Traders keep busy picking off opportunities on the long and short side. And patient investors who have better things to do with their time can collect cash.

In a bull market, everyone should make money simply by having their money in the market. It’s a bear market that sets us apart.

But with Wall Street partying over new all time highs for the Dow Jones index, how can we be in a bear market? Well, adjusted for inflation, the US stock market is still down more than 10% from its 2000 and 2007 highs.

Source: WSJ

And even though the market may be at an all time high, it’s still within what Murray Dawes calls a ‘widening distribution’. If we understand Murray’s theory correctly, chances are the stock market will be heading back down again soon. Here’s what the widening distribution might look like going forward, if it continues:

If the Widening Distribution in the Dow Continues
 

If the Widening Distribution in the Dow Continues
Source: Yahoo Finance, Nick’s Imagination

As you can see, there’s a whole load of ups and downs, but in the end the market just keeps going sideways. To an investor, that’s frustrating. To a trader like Murray, each one of those moves is an opportunity to profit.

In the end, despite all the ups and downs, the market is still going sideways. Until it experiences a proper breakout from this distribution, buy and hold isn’t going to work for a diversified portfolio of growth stocks. And there are plenty of reasons to believe Wall Street’s new highs aren’t a proper breakout.

Chris White of Dewiler compared today’s economic indicators to the last stock market peak in 2007:

  • GDP Growth: Then +2.5%; Now +1.6%
  • Unemployed: Then 6.7 million; Now 13.2 million
  • Food Stamp users: Then 26.9 million; Now 47.69 million
  • Fed’s Balance Sheet: Then $0.89 trillion; Now $3.01 trillion
  • Debt as a Percentage of GDP: Then ~38%; Now 74.2%
  • Total US Debt: Then $9.008 trillion; Now $16.43 trillion
  • Consumer Confidence: Then 99.5; Now 69.6
  • Stock Market Volatility Index: Then 17.5%; Now 14%
  • 10 Year Treasury Yield: Then 4.64%; Now 1.89%
  • Gold: Then $748; Now $1583
  • NYSE Average daily volume: Then 1.3 billion shares; Now 545 million shares
  • Dow Jones Industrial Average: Then 14164.5; Now 14,304

In other words, the economy is about half as good as it was in 2007, but the stock market is at the same level. If the US stock market halved to reflect what’s going on in the real world, that would bring us back to the bottom of Murray’s widening distribution. By the way, Murray would mention that this is the most likely outcome, but not the only possibility.

Back to what you should do about all this.

To be honest, a combination of all three investment strategies we mentioned is the ideal portfolio. For most of your portfolio, you should be in dividend paying companies that give you a return no matter what happens to the wider stock market.

While those stocks go up and down, you can calmly collect the cash they pay you to own them. You can also apply some ‘punting money’ to making specific bets in stories and investment opportunities you believe in. Right now, shale gas, gold stocks and biotech are on the lists of the office’s analysts.

But what most people are missing is the ability to be a little more active. If you can turn the stock markets toos and fros into profitable moves, imagine how that changes your investing outlook. Here’s a real example.

Back in 2009 and 2010, the Aussie stock market was moving sideways just like the American one is now, but on a smaller scale. Most investors were frustrated their stocks were going nowhere. Dividend paying investors sat pretty and there were plenty of small scale success stories that made punters money. But overall, things were pretty dismal.

Meanwhile, Murray Dawes identified the widening distribution. In April 2010 he made a bet that certain Aussie shares would tumble back to the bottom of the distribution. His subscribers captured the fall represented by the last arrow on the right below.

ASX 200’s Widening Distribution in 2010
 

Source: Yahoo Finance

Imagine making money while the stock market tumbles.

Rather than imagining it, why not give it a go? If the US market turns back down to the bottom of its distribution, Aussie stocks will likely follow. While there’s a metaphorical deer in the headlights, why not have venison for dinner?

Nickolai Hubble.
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Nick Hubble
Nick Hubble is a feature editor of The Daily Reckoning and editor of The Money for Life Letter. Having gained degrees in Finance, Economics and Law from the prestigious Bond University, Nick completed an internship at probably the most famous investment bank in the world, where he discovered what the financial world was really like. He then brought his youthful enthusiasm and energy to Port Phillip Publishing, where, instead of telling everyone about The Daily Reckoning, he started writing for it. To follow Nick's financial world view more closely you can you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails.
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