Because people often compare their portfolio results to the S&P 500, they often do not get a full appreciation of what is going on in the market. As Rick and I have been talking about, there is a stealth correction happening in many stocks, and an outright bear market in the energy space.
The 52 week lows are overwhelming the 52 week highs, despite the S&P 500 chopping along its highs. That happens because the biggest companies have not felt the correction yet, except for energy. The indexes place more emphasis on the biggest companies as market capitalization weighted averages, i.e. bigger companies count more than smaller companies. So, when the biggest companies hang in there, it gives an impression that there is nothing negative occurring with the stock market.
If one follows the SPDR Select ETFs which invest in different sectors of the economy, the component pieces of the S&P 500, you can see that there has been a rotation going on in the markets. It’s very difficult for somebody who isn’t a skilled trader to trade those rotations. In fact, it’s almost impossible for 90% of folks who don’t use good trading software.
What we can discern from the speed of the rotations is that there is money moving, but not much coming into the markets. That indicates weakness. What we are seeing right now is either the start of a bear market or a small correction that will lead to another leg up. It’s very hard to know whether this is a small correction or a new bear market. I suspect it’s a small correction, which will be in the order of 10% or so on the S&P 500, but worse for smaller stocks.
So, what should an investor do?
As I have said over and over, investors should buy valuable assets when they are cheap and hold for a few years. I know that is hard advice to follow emotionally, but I have just stolen it from much better investors.
We need to constantly remind ourselves that volatility equals opportunity, not necessarily risk. Risk comes from prices being higher than the value of an asset. We actually know that’s been occurring since it is cheaper in many instances to start a new company from scratch now-a-days than buy an existing one on the stock market. That’s actually a great indicator.
Often when we buy a value priced asset, it will become more value price, i.e. go down again. So while we do not want to try to catch falling knives, sometimes we’re not sure if the falling has stopped. We often see stocks that have fallen in price and land at a ledge. So, we buy. But then, the stock gets pushed off the ledge down to another. If you have done a good job with fundamental research, then your response should be to buy more. If your position sizing has been good, then you will be able to buy more if there are lower ledges.
I am following the advice of “buy more” in the energy space. In particular I like natural gas stocks for all the reasons covered in this MarketWatch article I wrote a few weeks ago: Four reasons for a boom in natural-gas stocks.
The beauty of natural gas is that it is not under any downward demand pressure. Ultimately, that means that supply will balance out. With the U.S., India and China going away from coal (at different speeds, but all with the goal of leaving coal), I’d expect that supply/demand balance and higher prices in natural gas to happen much faster than most think.
There are other opportunities too. If you want to find them, start with smaller companies that offer both growth and value. They are out there. That will be my focus in coming months for Fundamental Trends subscribers.