What Are the Warning Signs? Money and Markets by Mandeep Rai, Friday, July 24, 2015
The official Bull Market is still alive, although as you can
tell by this week's market activity, the euphoria many felt over the past
couple of years is in a bit of a lull. That has many people looking for signals
as to whether the old bull still has some life in it or if we're heading for a
correction.
Markets have rallied with few corrections since the
recession and financial crises of 2007-09, which saw a market drop of up to
60%. We're probably not going to get such a collapse again soon, but there are
some warning signs to be on the lookout for in regard to the market. Let's look
at those current concerns and some ways to protect yourself:
Companies are borrowing money at record levels to repurchase
their own stock. NYSE margin debt levels are extremely high, which in the past
has led to bursting bubbles.
We have a record number of unprofitable IPOs — companies are
going public to access capital markets for funding, even when they aren't
generating earnings. That's a risky and speculative game.
Mergers and acquisitions are up 20% year-to-date, adding to
the 101% rise in 2014. Inorganic growth could be a sign that a company's
internal prospects have topped out and that management needs to scramble to
purchase outside growth to satisfy near-term stockholder demands.
What are the warning signs to be on the lookout for in the
stock market?
The dollar is continuing to rise, and most analysts forecast
further increases. A stronger dollar hurts larger companies with international
operations, as it makes their goods more expensive compared with their foreign
counterparts' output. About one-third of the total sales of S&P 500
companies are generated outside of the U.S.
Earnings are slowing. Blame what you will — the weather, the
dollar, global slowdowns, etc. — but the fact remains that the stock market is
a function of the earnings of the companies in it. And even though companies
are beating (lowered) expectations, absolute growth for both sales and earnings
generation is troubling. If the market continues to rise, the math is simple —
you'll be paying higher prices for lower returns.
The overall price/earnings ratio is above average at 18.5x,
but it's still a ways off from the early 2000 pre-crash ratio of 29x.
Add in geopolitical risks and a potential rise in interest
rates, and the uncertainties just mount.
Does that mean you should just give up, get out of stocks
totally? No, not really. There is still money to be made. You just need to play
it safe: Study company fundamentals now more than ever and keep a good stash of
cash to buy quality companies on any knee-jerk declines. These are all signs I
watch closely for my Top Stocks Under $10 portfolio.
One investment that can help you protect against drops is an
old-fashioned hedge: the put option.
Put options can be bought against the stocks you hold. If
the stock's price falls, you have the right to sell your stock at the strike
price no matter how far below that the stock actually declines. Of course, if
the stock rises, the put option can expire worthless, but then you won't have
to worry too much, as you'll benefit from the rise in the share price.
Complicated? Yes. But once you get the hang of it, it can help limit any
potential loss.
Keeping your level of cash on hand high can also allow you
to move quickly to buy quality companies that are unfairly hit in any kneejerk
reaction to non-company-specific events.
Ultimately, any dip or shakeout in the market would be
healthy, and normalization of Fed policy away from emergency levels would be
long overdue. Any correction would be a buying opportunity, if you're picking
the right stocks. UBS pointed out that after an initial correction, the S&P
500 has gone on to rally 33% on average over the next two years.
"Source: moneyandmarkets.com", Mike Larson,
Money and Markets: A Division of Weiss Research, Inc. |
No comments:
Post a Comment