Don’t Worry When Investing In The Stock Market – Proceed With Caution

Stocks had another tough day yesterday. Not only is the Aussie market falling out of love with the Commonwealth Bank [ASX:CBA], it is also freaking out over some crazy North Korean playing war games.

Although the antics of North Korea’s megalomaniac leader are concerning, I don’t see the need to get overly worried about it. Not yet, anyway.

The market took that view overnight, with US stocks rising modestly. That set the Aussie stock market up for a better day today. But it’s still trading nervously. The banking sector, which accounts for nearly 30% of the ASX 200, is on the nose with investors.

Until the selling subsides in the banks, don’t expect the overall market to get much upward momentum.

So, while our stock market continues to pretty much do nothing, let’s check in with a sector I’ve been bearish on over the past few months — US tech stocks.

If we measure the sector by the performance of the NASDAQ index, then there’s not much to worry about. As you can see in the chart below, it’s corrected slightly over the past month, but the move is certainly not out of the ordinary.

In fact, it’s just a standard correction within an ongoing bull market

Source: Optuma
[Click to open new window]

However, there is a chance that the upward move could be running out of puff. At the bottom of the chart I have included an indicator called the relative strength index, or RSI. This is a short term momentum indicator.

As you can see, momentum has started to trend lower this year, while prices have continued to rise. This is a divergence worth noting.

I should point out that I have no idea whether this is a reliable ‘divergence’ indicator. I haven’t back tested it. I’m just pointing it out because I find it interesting.

Keep in mind I’m also pointing it out because it helps confirm my suspicion of US tech stocks right now. In other words, I’m engaging in confirmation bias.

This is something you should always be on guard for. Whenever someone makes an argument, they can pluck out any old fact that confirms their bias. If you’ve read many news sites or comment sections on the internet, you’ll know what I mean…

Still, I think it’s worth taking into account. Especially when added to other evidence.

Investors’ Market Psychology

For example, I’m especially interested in market psychology and how the mind of the market works. Our brains, which have evolved over millions of years, are simply not cut out for stock market investing. That’s why we tend to make. the same mistakes over and over again.

Our brains consist of an ancient reptilian base, a mammalian limbic system over the top of that, and a neo cortex (which is part of the limbic system, but distinctly larger in humans than other mammals).

When we engage with the stock market, it tends to fire up the core limbic system, the place where emotions like fear and greed reside. This mammalian part of our brain desires safety in numbers, because, in evolutionary terms, sticking with the herd promotes survival.

But if you stick with the safety of the herd in the stock market, more often than not it promotes money loss.

The way to make money consistently in the stock market is to always be ahead of the herd. Then, the idea goes, you enjoy the benefits of the herd jumping in. Before slipping away from the pack just as the vast majority come in, in joyous and apparent safety.

That’s the thinking behind my latest investment idea, which you can find out more about here. It’s definitely an ‘ahead of the pack move’.

But in relation to today’s discussion about tech stocks, I bring it up because Magellan Financial group [ASX:MFG] is in the process of raising a record amount of capital for a new listed investment company (LIC).

There are something like nine brokers on board to try and raise $1 billion-plus, which will be invested in global equities. Much of that will go into the tech sector, as fund manager Hamish Douglass is a self-confessed and self-promoting tech junkie.

According to the promotional quote for the LIC on the home page of my nabtrade account, Douglass says:

Technology is really starting to move and disrupt industries and Australian investors really need to think about how they’re positioned for the changes ahead.

If Magellan manages to raise $1 billion plus from Aussie investors on the rationale of investing in tech, then I’ll be even more worried about the NASDAQ going through a sizeable correction.

Because when a good chunk of Australia’s brokers are out there hustling for money to go into a global tech fund (and getting it), you know the story is in the price.

Because it’s only when people feel comfortable with an idea that they collectively throw $1 billion plus at it. And when it comes to the stock market, when there is collective comfort in an idea, you should start edging towards the exit.

It’s still early day for the NASDAQ. It needs to break below the July and May lows before you should become more bearish. But I wouldn’t be surprised if this huge raising by the tech-driven Magellan marks at least a temporary high for US tech stocks.

It’s certainly one I’ll keep an eye on for you.


Greg Canavan,
Editor, Crisis & Opportunity

Greg Canavan is a Feature Editor at Money Morning and Head of Research at Fat Tail Investment Research.

He likes to promote a seemingly weird investment philosophy based on the old adage that ‘ignorance is bliss’.

That is, investing in the Information Age means you have all the information you need at your fingertips. But how useful is this information? Much of it is noise and serves to confuse, rather than inform, investors.

And, through the process of confirmation bias, you tend to read what you already agree with. As a result, you often only think you know that you know what is going on. But, the fact is, you really don’t know. No one does. The world is far too complex to understand.

When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases.

Greg puts this philosophy into action as the Editor of Crisis & Opportunity. As the name suggests, Greg sees opportunity in a crisis. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines traditional valuation techniques with charting analysis.

Read correctly, a chart contains all the information you need. It contains no opinions or emotion. Combine that with traditional stock analysis and you have a robust stock-selection strategy.

With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the basic, costly mistakes that most private investors do every time they buy a stock.

To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Money Morning here.

And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here.

Official websites and financial e-letters Greg writes for:

Money Morning Australia