Friday, May 6, 2011

Commodities Plunge, Yields Move Lower - What to do about Stocks?

There seems to be increasing evidence that the world's economy is turning a little weaker.

Jeremy Warner writing in today's London Telegraph does a good job at summarizing some of the recent signs that would suggest the recent trends are turning less favorable.

He lists 10 different reasons for his pessimism, which can be found by clicking on the link, but the general idea is that the plunge in bond yields and commodity prices are indications that investors are turning cautious.

Ten reasons for thinking the world economy is turning soft – Telegraph Blogs

I've received a few calls today from clients wondering what changes they should make, if any, in their portfolios.

Mostly I've been saying to just be patient. There is no doubt that the old stock trader's axiom of "Sell in May and go away" is being repeated by many investors as justification to head to the exits.

That said, the problem with any short term trading strategy is that you really have to make two decisions: first, when to sell; and, second, when to get back into the market.

Last year, for example, selling in May looked pretty smart until the end of June. However, the market jumped by nearly +25% during the second half of 2010, so you would have had to be pretty nimble.

So, what I keep referring back to the three rules of trading that veteran market strategist Ned Davis that I first wrote about back in March (please see blog post dated March 11, 2011)

If Ned's rules are right, we're still OK on stocks. Here they are again, and my comments on the current situation:

1. Don't fight the Fed - the Fed's QE2 program will be ending at the end of June, but I don't get the impression that monetary policy will be tightening any time soon. In fact, even the European Central Bank (which raised rates a month ago) gave strong hints that it too will be slow to tighten any time soon;

2. Don't fight the Tape - the tone of the market remains positive, despite a rocky few days earlier this week. Investors might want to reduce stock positions, but the investment alternatives aren't all that interesting;

3. Be Wary of Crowd Sentiment at Extremes - bullish sentiment had been very strong a few weeks ago, but the buzz seems have lessened, and there are more calls for caution. This is good - too many bulls usually translate into mediocre returns.

So, while I too am a little concerned about the economy, I don't see any compelling need to change my basically bullish stance on stocks at this point.