Why you Should Invest in Common Sense

As fear of a correction across global markets increases, so too does the Dow Jones Industrials.

The index was up 200 plus points on Friday, or 0.9%. The S&P 500 was even stronger, up 1.2%, while the NASDAQ jumped 1.3%.

There is clearly some FOMO going on in global stock markets right now. That is, Fear of Missing Out. Missing out on what, though? Buying stocks on high price-earnings multiples at what appears to be the end of the cycle?

The caveat here is ‘appears’. No one knows where the end of the cycle is. Only hindsight reveals it. But you don’t need to know anyway. You just have to use your common sense.

This can be difficult when emotions take over, which is what seems to be happening now. Collective greed is enveloping the market. The rational part of your brain (the common sense boss) doesn’t get much of a say at such times. Rather, it’s sniggered at and told it doesn’t get it.

To help my common sense boss take control of the situation, I look to the charts. Charts take the emotion out of the equation and tell you how it is. They don’t allow you to construct your own illusion.

Let’s take a look at a chart of the NASDAQ to put things into perspective.

My simple question is this: Do you really want to buy here?

Source: Optuma
[Click to enlarge]

From the cycle low in March 2009, the NASDAQ is up nearly 500%. After the low in early 2016, the pace of gains picked up, and since the start of this year, the index has gone vertical.

So ask your rational self, is this a good time to jump on board?

Have a look at this chart the next time you’re feeling a little too good about your share portfolio. If you’re looking at your account balance too often, then you can bet the market will soon hand out a harsh lesson.

Having said that, let’s try and keep perspective. Plenty of people will argue that we’re now in a bubble of 1999 proportions. In a moment I’ll show you a chart that debunks this theory.

In it, I’ve changed the scale to reflect percentage gains, rather than index point gains. This makes a difference when an index moves higher over time. For example, a move in the NASDAQ from 5,000 to 6,000 points (20%) is the same as a move from 1,000 to 1,200 points.

At higher levels, the index needs to increase much more in terms of points to achieve the same percentage gains.

To adjust for this effect, you can change to a ‘log’ scale if your software allows it. 

Before I show you that chart though, let’s have a look at the ‘NASDAQ is in a bubble worse than 1999’ chart:

Source: Optuma
[Click to enlarge]

You’ve got to admit, that does look a little worrying.

But when we adjust for the effect of large numbers, it’s not so scary.

Source: Optuma
[Click to enlarge]

I’m not saying it’s all good. Only that it’s not bell-ringing bubble top territory.

It is solid correction time territory though. So put your common sense boss man in charge and resist whatever buttons your emotional minions are trying to press right now.

Or maybe you’re not feeling it at all? If we look at the Aussie market, it’s been all common sense and no FOMO. Although it depends on what sector you’re looking at.

Tech stocks and resources have done very well. Banks have underperformed. Due to their large index weighting, they have dragged the averages down.

However, one sector that I think could do very well in the months ahead is gold.

Let me show you a final chart for today. I showed this to subscribers of my investment advisory, Crisis & Opportunity last week.

It shows the US dollar gold price getting very close to a major breakout:

Source: Optuma
[Click to enlarge]

If it breaks above the July 2016 high around US$1,380 an ounce, it will represent a four year high. I think at this point you’ll see a lot of buying and gold will quickly rally to around US$1,500 an ounce.

Gold isn’t there yet. It might need to consolidate around current prices first. But if it does break through, we’re off to the races.

One other point to note. While the NASDAQ is nearly into its 9^th year of expansion (as are the other major US indexes) and is up nearly 500%, gold only bottomed at the end of 2015. And at this early stage, it’s only up 30% from the lows.

Let your common sense have a think about that.

Regards,

Greg Canavan,
Editor, Crisis & Opportunity