By most historic metrics, the market is showing signs of a significant top. Here are just a few key metrics:
1) Investor sentiment is back to super bullish autumn 2007 levels.
2) Insider selling to buying ratios are back to autumn 2007 levels (insiders are selling the farm).
3) Money market fund assets are at 2007 levels (indicating that investors have gone “all in” with stocks).
4) Mutual fund cash levels are at a historic low.
This final point is key. Mutual funds are the “big boys” of the investment world. If they have become fully invested in the market, this means there are few buyers left to push stocks higher. This is evident in the fact that every time mutual fund cash levels dropped, stocks collapsed soon after (see chart below).
In plain terms, the odds are high that a Top is forming in stocks. With that in mind,
if your portfolio is heavily invested in stocks, now is a time to be taking some profits. If you can, consider moving a sizable chunk into cash.
The market is extremely tired and the systemic risks underlying the Financial Crisis are in no way resolved. With investor complacency (as measured by the VIX) back to pre-Crash levels, the Fed withdrawing several of its more significant market props, and low participation coming from the larger institutions, this market is ripe for a serious correction.
I’m not saying this will immediately happen. But at some point there will be a new round to the Financial Crisis. When that happens, we WILL have another Crash. Indeed, it is quite possible that stocks are making a VERY significant top, so being heavily invested in stocks going forward doesn’t make much sense. Take some money off the table. If you need a place to put it, I suggest physical cash or Gold/ Silver bullion.
If You MUST Stay Long, Shift to Quality
If you DO have to stay invested in stocks, now is the time to be shifting out of junk into quality. The market rally from March 2009 has largely been lead by junk companies (financials, retailers, etc). Meanwhile, quality has lagged dramatically.
As an example, let’s compare the performance of Coke (KO) to Bank of America (BAC).
KO is one of the best, most profitable brands in the world. The competitive moat around this business is extraordinary and it remains one of the most easily recognized franchises on the planet. You can drink six glasses of Coke a day and still enjoy it the next day. That quality is almost nowhere to be found in any other food/ beverage on the planet: even chocolate would get old after six bars a day.
BAC on the other hand has swallowed Countrywide Financial AND Merrill Lynch’s garbage assets. It is effectively insolvent based on its derivative exposure alone (the company has derivatives equal to 3,000% of assets). BAC’s balance sheet is like an open sewer and without serious government intervention the company would not even exist right now.
And yet, BAC’s stock has risen nearly 200% since the March ‘09 lows… while KO is up roughly 50%.
This relationship works to the downside as well. What I mean is that when stocks come unhinged, Quality (Coke) then outperforms Garbage (Bank of America) hands down.
So, if you HAVE to remain invested in stocks to the long side for whatever reason, now is the time to be moving into high quality companies. This means finding companies with low debt, lots of cash, strong results (KO actually GREW revenues in 2008), and significant competitive advantages.
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