Don't Get Carried Away by the Market Rally

http://online.wsj.com/article/SB10001424052748704323204576084283773099512.html

Don't Get Carried Away by the Market Rally
By BRETT ARENDS , Wall Street Journal, JANUARY 16, 2011

It's hard to stay cool in a hot market.

Wall Street's been booming lately. The Dow Jones Industrial Average has risen 22% since last summer, and the Nasdaq Composite 30%. Market spirits are up. The optimists are out in force. And after an impressive 2010, stock-market strategists are forecasting good gains again for 2011.

At times like this, a lot of investors may feel an urge to throw caution to the wind and jump in head first. After all, everyone says the market's going higher, right? You wouldn't want to miss out on the action! Maybe you should get in while you still can?
[sunlede16] Wesley Bedrosian

It's enough to test the resolve of the most disciplined investor.

Time to take a deep breath. Stay focused. And remind yourself, once again, to stick to your long-term investment discipline.

Yes, it has been a sharp rise. And maybe Wall Street will go higher. But maybe it won't. No one really knows. Stock-market fever is one of your biggest enemies as an investor. Here are seven antidotes. Take with half a glass of water as needed.
1. Don't trust your feelings.

The real reason we all feel an urge to buy shares after the stock market has risen has nothing to do with the economic outlook or investment risks.

It's pure instinct. We're hard-wired to run with a stampeding herd, and to seek safety in numbers. There's a reason for that. For thousands of years, that successfully kept our ancestors from being eaten by lions. But these feelings are a terrible guide to investing. There is no urgency. Over time, disciplined investing beats short-term speculation, hands down.
2. Don't trust the crowd either.

They're usually wrong. Time and again, studies show the public invests at the wrong time -- they get bullish and buy after shares have risen, and then panic and sell after they have fallen.

Financial firm TrimTabs Investment Research found the average investor lost money during the last decade, even though the market ended up about even. And financial-research company Dalbar has found the same thing going back decades. Someone who invested $1,000 in the Standard & Poor's 500-stock index 20 years ago and left it there would have had about $5,000 by the end of 2009.

If you had followed the crowd -- buying in booms, selling in slumps -- you'd have less than $2,000. So don't listen to the crowd. They have a terrible track record.
3. Ignore the short-term news, good or bad.

It may move stock prices in the near term, but it will have almost no long-term relevance, and it will quickly be forgotten.

Most of the stock market's value is based on the profits companies will make over many decades into the future. The next few months count for little.

Analysis by Ben Inker, a director at top investment company GMO, found that even the next 10 years' profits account for only about 25% of the stock market's value. Who cares about next quarter's earnings?
4. Don't get too cheerful.

The recent rise is on a lot of thin ice. The government is borrowing $1.3 trillion a year from the future and spending it now to jump-start the economy, while the Federal Reserve is printing even more money.

Our overall national debts -- including the government, households and corporations -- are already at record levels and rising.

Despite this flood of money, housing prices have actually started falling again, and the jobs picture is much worse than the official figures suggest.

Meanwhile, China and other emerging markets are battling raging inflation, raw-materials costs have soared and fears are rising again of another debt crisis in Europe. There are plenty of reasons to stay sober.
5. Please, ignore the jock talk.

Too many TV market pundits talk like they're on ESPN. It gives the stock market a phony air of urgency and excitement.

No, Wall Street isn't "on a roll" or "racking up a winning streak." And nobody is "pulling the trigger" on a purchase.

What a con.

If you're buying, higher stock prices are bad, not good. Do these pundits go to the supermarket and say, "Wow! We gotta pull the trigger on more hamburger -- it's going up!"

Stocks aren't like a kicked football either: They're not in motion. "The stock market is going up" really just means "the stock market has gone up." So if shares are a little more expensive today than they were yesterday, does this still make you want to buy?
6. Consider how often Wall Street holds a sale.

Do you like paying full retail? Shares have risen quite a ways. Are you really sure they won't get cheaper again -- in relative, or absolute, terms?

That's quite a bet.

At points in the last 10 years we've seen the Dow at 6600, Amazon.com at $6, Exxon at seven times forecast earnings, tax-free municipal bonds paying three times as much as taxable Treasurys and inflation-protected government bonds basically given away for next to nothing.

The financial markets seem to hold sales about as often as your local discount furniture store. Why should the next 10 years be any different?
7. Look at who's cheering this rally.

Most of those waving pom-poms right now were doing exactly the same in 1999 and in 2007. Are they a reliable guide -- or just a broken watch that always says it's time to buy?

Meanwhile, most of the people who accurately predicted the last crisis are pretty cautious right now -- such as John Hussman at Hussman Funds or Jeremy Grantham at GMO. Plenty of data suggest that shares are on the pricey side, and that long-term returns from these levels may well prove disappointing.
—Email: brett.arends@wsj.com