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Samples of Archived Commentaries:

May 2006

Bull Market in the Late Innings

Overall, stock indexes were fairly flat during the month of April. Some averages were up a bit (Dow, S&P 500, S&P Mid-Cap) and some were down a bit (Nasdaq, Russell 2000 Small-Cap). However, those minor changes in price during the month mask some significant events and interesting shifts taking place below the surface of the major indexes.

Not the least significant of these events was the shift of the Market Indicator to "Negative" on April 17. Also not an insignificant event was the following day's performance in the stock market -- a 200-point rally in the Dow. The difference between the two events is that one is a short-term event and the other is a development with longer-term implications. While the strong showing by stocks immediately after the Market Indicator flashed a warning sign is not an obvious endorsement of that warning, it also does not invalidate the message being sent by the "Negative" reading (and even allowed for subscribers to decrease their exposure to stocks at higher levels.) And though the rally took most averages to new highs for the current bull market and cannot be dismissed, there are plenty of reasons why investors should be growing wary of this aging bull market.

The first reason is obviously the implication of the "Negative" reading of the Market Indicator. As seasoned followers of the Market Indicator know, this is not meant as a pinpoint signal of the precise top of a rally. Rather, it is a warning sign that the stock market has lost sufficient underlying support that it is currently at risk of an intermediate-term correction. As stated in a recent Alert, the Market Indicator consists of several components that measure certain segments and momentum being exhibited by the stock market as a whole. (An example is a measure of the number of stocks currently in an uptrend vs. the number of stocks in a downtrend.) Also as stated in the Alert, these components are intermediate-term in length (several months) and must be in unison to warrant a shift in the Market Indicator. Therefore, by the shift to "Negative", there is no question that the market has experienced substantial deterioration. It is like the game "Jenga" where players take turns removing blocks from a tower, until eventually, when there are not enough blocks to support it, the tower falls over. Though it may not be obvious from the major indexes, blocks are slowly being removed from this stock market rally.

Another area of concern is the amount of money, or market fuel, that is out there to support the rally. Typically, it is good for the stock market when investors are putting money into stocks or stock funds. However, there comes a point where there is such a large inflow of money into stock funds that it becomes extreme, and signals that much of the potential fuel to support the market has already been invested. We are likely close to that extreme now. According to the Investment Company Institute, over the past quarter, investors have put an average of over $30 billion a month into stock funds. This is the second highest monthly inflow ever, behind only the spring of 2000 when the stock market topped out. And while some make the argument that there is a large pool of money in money market funds, the ratio of assets in money market funds to assets in stock funds is the lowest in 20 years. We can thus conclude that market fuel (investment dollars) is on the wane.

One more warning that this is not the ideal time to be aggressive in the stock market was also touched on in a recent Alert. There is a tendency for the stock market to rally from November 1 through April, and then produce no gains from May 1 through October. This pattern, known as "Sell in May and go away", is one of the most consistent historical patterns in the stock market. Though, like all other market phenomena, the pattern does not perform exactly how it is described every single year, the facts support paying the pattern its due attention and respect. If one invested in stocks (the Dow for example) from November through April every year and switched to bonds every May through October, $10,000 invested in 1950 would have grown to $461,774 in 2004. However, if that investor had done the opposite, invested in bonds from November through April and stocks from May through October, the $10,000 invested in 1950 would actually have declined to $9,681. So with the pattern holding true to form with stocks rallying nicely this past 6 months, it at least should cause investors to be aware now that we've entered the historically under-performing 6 months.

The key in retirement investing is not squeezing every last dime out of a stock market rally. Rather it is to invest when the odds are in your favor and decrease your exposure when the odds are not. While the stock averages can still rally for some time, and quite possibly make new highs, the evidence shows that risk is on the rise and this is not the best time to commit more assets for investment. It may not be the bottom of the ninth inning for this rally, but it is definitely in the late innings.

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