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Sunday, August 21, 2011

Two compelling reasons to buy stocks now

In this post, I will present one technical indicator and one fundamental factor that provide compelling support for buying stocks now.  The first is a technical indicator - the percentage of stocks trading on the New York Stock Exchange that are currently below their 200-day moving average.  This indicator takes the previous 200 trading days and looks at their closing prices for each.  By adding these 200 prices together and then dividing by 200, we arrive at a 200-day moving average for the stock.  The 200-day moving average is a very strong indicator, since the average is taken over such a long period of time (200 trading days).  When more than 80% of the stocks that trade on the NYSE have broken below their 200-day moving averages, historically speaking, the stock market has rallied, both in the following 15 days, and in the following 3 months, both by healthy percentages.  We currently have only 15.22% of all stocks on the NYSE trading above their 200-day moving averages, which means that almost 85% are below their 200-day moving averages.  This is a very strong indicator that the market is about to reverse to the upside in the near future.

On the fundamental side, the S&P 500 is trading at only 11 times its next 12 months of earnings.  We take the earnings estimates for all 500 stocks and add them together using the correct proportion that each stock holds in the index, and then divide the current level of the S&P 500 by the earnings estimate.  Th long-term historical average for the S&P 500 is 15 times earnings.  At just 11 times, we are trading at a deep discount to that average.  However, the rub here is that these are, in fact, only estimates from analysts for what they think companies will earn over the next 12 months.  To the extent that these analysts could be wrong, and they are wrong a lot, we can't trust this indicator all that much.  However, even if they are overly optimistic, which is likely the case, we are still very likely trading at a discount to next year's earnings.

Fear is dictating the direction and trading in the market.  We will need some kind of major reassuring event or announcement to allay those fears, and to get investors to come back to the table on the buy side.  For those willing to take the risk, and who are long-term investors, as opposed to speculators and traders, I feel that there are attractive bargains in high-quality stocks.  There can be no reward without risk!

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