When Not to Buy Stocks

The stock market’s really going for it.  The S&P 500’s just a scratch from its October 9, 2007, all-time high of 1,565.  Is it time to pop the champagne bottle and celebrate?

We’ll let you decide.  But do you recall what happened just after the October 2007 high was notched?  The stock market then went into freefall for nearly a year and a half.

By March 8, 2009, the S&P 500 bottomed out at 676…for a loss of 56.8 percent.  Since then the S&P 500’s run up over 120 percent.  Some say it will go higher.

Perhaps it will.  But if you believe that the key to making money in the stock market is to buy low and sell high – not buy high and sell low – then now is not the opportune time to invest.  Of course, there’s the possibility you could buy high and sell higher.  However, like jaywalking across an interstate highway, the potential risk and reward are not very favorable.

Still, people are tripping over themselves to get into stocks at a record pace…

“For the week ended Jan. 16, U.S. investors moved a net $3.8-billion (U.S.) into equity mutual funds,” reports The Globe and Mail.  “That followed the $7.5-billion inflows in the previous week (along with another $10.8-billion directed to exchange-traded funds).

“Add it up, and you’re looking at the biggest two-week inflow into stocks since April, 2000, according to Lipper.”

The Uncanny Ability to Buy High and Sell Low

Unfortunately, for investors, April 2000 was a terrible time to buy stocks.  The S&P 500 peaked on March 24, 2000, at 1,527.  After that it took a long 49 percent swan dive down to 776 on October 9, 2002.

All the smart fellows that rushed into stocks in April 2000 saw their investments get cut in half.  What to make of it…

People want to buy stocks right now because they are approaching new highs.  The right time to buy stocks is not when they are at record highs…but when they are at bear market lows.  During market lows, like March 2009, most people don’t buy stocks.  They sell.

Obviously, investing psychology goes contrary to other purchases.  While humans can quickly discern a bargain price for a pair of jeans or a flat screen TV, with stocks, they have the uncanny ability to buy high and sell low.  There’s something about the march to new highs that causes a person’s head to go soft with visions of easy riches.  Similarly, there’s something about a market crash that causes people to panic out of their positions at the very moment they should be loading up.

Naturally, we don’t know the future any more than the next guy.  Perhaps stocks will rise to unimaginable new highs.  At this point, however, we won’t bet our hard-earned money on it.  Particularly, with the cool gusts of winds blowing towards the economy…

When Not to Buy Stocks

To be clear, the stock market and the economy are two entirely different animals.  For extended periods of time, GDP can go up and stocks can go down.  So, too, there are periods when the stock market can outrun the economy.

For example, between 1964 and 1974, U.S. GDP increased nearly 125 percent.  But, over this time, the S&P 500 lost about 25 percent.  Conversely, between 1974 and 2000, GDP increased roughly 583 percent, while the S&P 500 spiked up approximately 2,400 percent.

Next Wednesday we’ll find out the Bureau of Economic Analysis’ 2012 annual GDP estimate.  It’s likely it’ll be somewhere between 2 and 3 percent.  Yet, for the year, the S&P 500 increased 11.6 percent…roughly 400 to 500 percent faster than the economy.

The point is, there can be vast disparities between the stock market and the economy.  While a booming economy’s generally good for stocks and a receding economy’s generally bad for stocks, sometimes, for long periods, the two don’t always move closely in tandem.  Eventually, however, they must come into alignment…even when the Fed’s increasing the monetary base by $1 trillion per year.

Right now the stock market, as measured by the S&P 500, is rapidly approaching its record high.  At the same time, investors are pouring their money into stocks at record rates.  These may be indications that, at the very least, a pullback is coming.  What’s more, sooner or later, all the buyers will be back in the market and prices will have to fall for shares to clear.

In short, there are times to buy stocks…now is not one of those times.

Plus, don’t underestimate the damage the higher payroll taxes will do to the economy in 2013.  This amounts to a reduction of household incomes by a collective $125 billion.  This also amounts to a reduction of consumer spending by about $125 billion.  Low growth, weak employment, and rising food prices, among other things, will impact the economy in 2013.

The stock market will eventually figure this out.  Most investors won’t until it’s too late.  That’s when they’ll sell, at the bottom, like they always do…at the very moment they should buy.

Sincerely,

MN Gordon
for Economic Prism

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