Don't make the mistake of investing by looking backwards. The market has had a good run, but this one warning sign suggests it may be coming to an end.
A friend called me today. His brother-in-law wanted to run the names of some companies past me to get my thoughts on them. It was the first of 2 warning signs…
1) The 'friend-of-a-friend' warning sign -- being twice removed, it sometimes reminds me of the mug punter who is keen to tip you the winner of the Grand National.
2) Because I write about the stock market, people assume I have intimate knowledge of all companies on the stock exchange. I don't. It's like me asking a football fan what he thought about the midfield of the Andorra international football team.
Anyway, for what it's worth, here's the list…
You may detect a few trends…
- The list consists of 3 mining companies and 2 oil companies, otherwise known as resource stocks.
- Resource stocks were hot during the 2003 to mid-2008 bull market, with some like Tullow Oil soaring almost 10 times in value.
- The resources bubble well and truly burst from mid-2008 to early 2009. Vedanta for example slumped from a 2008 high of over 2,700p all the way down to as low as 380p, an 86% crash.
- Resource companies have been on a tear in recent months. Green shoots of recovery have been detected in far away places, and the share prices of resources companies have benefited exponentially. Premier Oil has bounced from a late 2008 low of 465p all the way back up to 1,189p, a jump of 156%.
- Late last week saw the share price of many resource stocks surge higher again, with Rio Tinto rising 10% on Friday alone after they scrapped a deal with China's Chinalco, instead teaming up with BHP Billiton (LSE: BLT) and announcing a rights issue.
A Nasty Habit
Call me an old Fool, but I see all this as a bit of a warning sign. Investors have a nasty habit of buying at the top and selling at the bottom of the market.
Apart from one friend, who's been invested in cash for a couple of years, no-one was ringing me up in March this year asking for investing advice. In fact, the phone here stopped ringing in September last year.
Why is it that people are attracted to the stock market after it has risen? We all like a bargain, so why weren't we keen to snap up all the bargains on offer just a few months ago?
I mean to say, if Tesco (LSE: TSCO) had a promotion on some vintage 1999 Claret at £5.99 a bottle, would you buy it today or wait a couple of months until it jumped back to its normal price of £12.99?
Investing Through The Rear Vision Mirror
Unlike quaffing wine, in the short-term, the stock market moves back and forth based on emotion. Back in March, the underlying emotion was fear. Most investors were fearful the bottom was going to fall out of the market. They'd already lost thousands, and with the market falling every day, were fearful of throwing good money after bad.
They were investing through the rear vision mirror. Because the market had recently been falling, they assumed it would keep falling. Most people realised it couldn't keep falling forever, but many were convinced it would fall another 15% from what has (so far anyway) turned out to be the low point of this bear market.
The Only Way Is Not Up
Fast forward to today and the market has been rising strongly. Resource stocks in particular have jumped higher, with many having doubled or more in the space of a few short weeks. It is in this environment I get the phone call essentially asking for approval to invest in the stocks listed above.
I can't help but thinking this is another classic case of investing through the rear vision mirror. The market has had a great run. The FTSE 100 has jumped almost 30% off its March lows. People are thinking the only way from here is up.
There is nothing wrong with thinking the market will rise from here. In 10 years time, it will almost certainly be higher. As for where it will be next week, or next month, I really have no idea.
I can't help but think the brother-in-law of my friend is hoping for another quick 30% gain. Because he has chosen volatile resource stocks, he may be hoping for even more -- 50% or more.
Hope Is Never Enough
Hope is the key word. When it comes to stock market investing, you need more than hope. You need skill. And more importantly, you need patience.
I wonder how this person would react if the market suddenly went into reverse and declined. Given the run we've had, it is certainly possible. Would he sell, just because the market is falling? I wouldn't be surprised.
I think many of the easy gains are behind us. When I get phone calls such as the one I received today, the contrarian in me sees it as one big warning sign. There is definitely no need to panic, but it reiterates my view that it's probably a decent time to take some profits.
More on the economy and the markets:
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> Bruce Jackson does not have an interest in any of the companies mentioned in this article.
