Yellow Light: Investors be Cautious

The DJIA has risen nearly 48% since the market low in March 2009. According Jason Zweig, a well-know value investor, states that the Dow Jones Industrial Average in its 113 year history has only had six other rises that have been faster. In 1930, the DJIA rose nearly 46.5% and then lost over 50% of its value in 1931. Then in 1971, the market was up nearly 47% and then declined almost 40% over the next 18 months. In 1975, similar results. The only other market rise of similar magnitude that resulted in positive gains after a 40%+ rise was the bull market from 2002 to 2004.

Currently, market valuations measured by price to earnings ratios are 18.4, above the long term moving average of 16.3. Also, corporate CEOs and insiders are selling nearly 31 times more stock than they are buying. The normal ratio is 7 to 1. This suggests that corporate executives are not encouraged about future earnings prospects.

Investors have become overly-confident in their prospects for future gains. Indeed, the markets have had an impressive run over these summer months, but trading volume is well below average and corporate earnings have been lifted by massive cost cutting. In order for stocks to move higher from this point there needs to be a major shift from cost cutting to corporate revenue increases.

A hint of advice. 401(k) investors continue to dollar-cost average each month and avoid trying to time the market. Everyone else: the yellow light is flashing, proceed with caution.

by David A. Mascio