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Where the Market Goes NextBy
Wednesday, January 19, 2011
While most investors were scared in 2010, my True Wealth newsletter readers made a lot of money...
For the second half of 2010, most investors were scared of the economy and avoided the stock market.
But in True Wealth, we stepped up and bought. We took as much risk as we ever have in the newsletter. We bought riskier "leveraged" funds, including ROM, a double-long tech fund, and SOXL, a triple-long semiconductor fund. Buying funds like these increases your risk... but magnifies your gains if you're right.
It was the right call. Those funds soared. And we did the right thing, buying when everyone was scared.
Today, I see the opposite situation...
Investors are more complacent than they've been in many years (as measured by the Volatility Index – the "VIX"). The last time they were this complacent was July 2007... Afterward, stocks proceeded to have their worst crash since the Great Depression. They lost over half their value before bottoming in March 2009.
 But complacency itself doesn't cause a crash. Stocks can continue to move higher as investors are complacent.
It's more of a sign of a top when the "dumb money" is piling into stocks – when the dumb money is optimistic. Here's how my friend Jason Goepfert (of SentimenTrader) puts it:
The Dumb Money is usually right during the trend, but when the dumb money gets extreme, the market consistently turns [down].
History suggests that when these traders are confident, we should be very, very worried that the market is about to decline. In practice, our Confidence Indexes rarely get below 30% or above 70%. Usually, they stay between 40% and 60%. When they move outside of those bands, it's time to pay attention!
Right now, the dumb money is at an extreme... Jason's Dumb Money Confidence Index is at 79% – its highest level in years...
So investors are complacent (as the VIX shows). And the Dumb Money is supremely confident (as Jason's research shows).
In short, where do I think the market goes next? The very worst case would be like what we just went through from July 2007 to March 2009. I don't expect we'll see that. But you should have your portfolio positioned for a flat stock market, at best, over the next two to three months.
While everyone else is optimistic, now is a better time to take some profits and reduce your risk instead of trading aggressively.
Good investing,
Steve
Further Reading:
Last April, Steve was singing a similar tune. "Now, my friend, is a time to be fearful," he wrote. "I believe we're near the end of that great bull run." A week later, the S&P 500 hit its highest level in 18 months, a level it didn't hit again for seven more months. The Dumb Money Confidence Index was at 75% back then... it's at 79% today. Read more here: Be Careful Now: Record Optimism in Stocks.
Investor sentiment is a useful tracking device in bear markets, too. In September, a recent poll showed "only 21% of respondents were 'bullish'," prompting Steve to predict stocks would be higher by December. Sure enough, the S&P 500 was up over 12% just 90 days later. Learn more here: There's a 98% Chance Stocks Will Be Higher in 90 Days.
Market NotesTHE URANIUM TRADE IS OFF TO A BIG START Commodity investors take note: The "big boy" of uranium just struck a new 52-week high.
Back in July, we noted how the blown-out uranium sector was breaking out of the brutal downtrend it began in 2007.
The bull case for uranium – the fuel for nuclear reactors – is that "emerging" Asian nations are embarking on a building spree of nuclear plants to meet a of their growing electric needs. Meanwhile, new supply won't keep up with this growing demand.
The largest and most liquid way to take a position in uranium is with Cameco (CCJ). You can think of CCJ as the "ExxonMobil of uranium." As you can see from the chart below, we're fair uranium timers at DailyWealth. Cameco is up 57% since we noted the uranium downtrend was over. It's all part of one of the biggest investment trends you'll find anywhere – the stupendous energy demands coming from "Chindia."
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