What’s Fuelling the Stock Market?
When it comes to personal finance and planning for retirement, nothing is as lucrative as the stock market. In fact, more wealth has been created through the stock market than any other business.
And by the looks of it, the current interest rates will continue to make the stock market a much more attractive investing alternative to bonds.
In 2008, the Federal Reserve stepped in with its generous bond buying program (quantitative easing) to help kick-start the economy after it slipped into a recession in late 2007. By artificially lowering the short-term lending rate to near zero, the Fed hoped banks would lend more money to businesses and people.
This has been a mixed blessing for investors. In a high-interest environment, fixed income assets like Treasuries, bonds, and certificates of deposit (CDs) are an important part of most investment portfolios. They are designed to provide investors with a place to park their retirement money. Fixed income assets are also supposed to provide a stable, reliable income stream. By lowering the federal funds rate, the Federal Reserve removed “income” from fixed income investments.
On top of that, keeping interest rates artificially low has made it cheaper to borrow. The low-interest-rate environment is generally recognized as being the fuel that has propelled the stock market increasingly higher.
The S&P 500 is up 200% over the last five years and closed above 2,000 for the first time ever in August 2014. The Dow Jones Industrial Average has advanced 166% and closed above 17,200 in September.
While many economists and analysts have been warning about a major correction, it has not yet happened. That said, bull markets usually don’t come to an abrupt end until fundamentals deteriorate and investor liquidity gets pulled from the stock market, neither of which has occurred, so far, in 2014.
In fact, the second quarter was very strong. Overall earnings for companies on the S&P 500 increased eight percent year-over-year, while revenues were up 4.4%. The market strength was broad-based and driven by top-line growth—not just cost-cutting. (Source: Shinal, J., “First Take: Corporate America ends monster earnings quarter,” USA Today web site, August 21, 2014; )
Will the Bull Market Keep Going in 2015?
Will the stock market continue to do well in 2015? It all depends on when the Federal Reserve decides to start increasing interest rates. Initially, the Federal Reserve said it wouldn’t raise interest rates until the U.S. economy was on sustainable economic footing.
Chances are extremely remote that the Federal Reserve will raise rates in 2014. This bodes well for the broader U.S. stock markets. Most think the Federal Reserve will raise interest rates in 2015.
But when? And how could it impact the stock market?
If the Federal Reserve raises interest rates in March 2015, it’s possible the stock market will go through a short-term correction. Raising interest rates by 50 basis points could negatively impact the broader economy, making it more difficult for people and businesses to borrow and lend money.
If it does raise rates, the Federal Reserve will continue to monitor the economy and decide whether or not to move rates higher or lower. If it doesn’t raise rates, investors will probably remain bullish and send the stock markets higher over the coming months.
The Federal Reserve will meet again in October 2015. Raising rates in October would allow the U.S. economy more time to establish itself economically. It would also allow the U.S. more time to figure out how the global economy is doing.
Because an interest rate hike in October 2015 would be expected, investors would see the increase as less of a shock. As a result, the stock market and major U.S. stock indices would be prepared to absorb the expected hike. Should corporate earnings be solid, the bull market would, in all likelihood, continue.
Two Strategies for Finding the Best Stocks in a Bear or Bull Market
When it comes to finding the right stocks, it doesn’t matter if we’re in a bear market or bull market—because it’s virtually impossible to predict market tops and bottoms. As a result, it’s best to concentrate on solid stocks with great long-term growth potential. And the only way you can do this is by doing your homework.
Whether you’re a seasoned investor or new to the stock market, when it comes to looking for stocks to invest in (penny stocks, small-caps, mid- and large-caps) most investors follow two schools: technical analysis and fundamental analysis.
Investors who use technical analysis believe that chart patterns and past price performance can predict future price movements. Examples of technical indicators include price data (open, low, high, close), moving averages (200-day and 50-day), volume, relative strength index (RSI), and money flow index—essentially, anything to do with price.
A fundamental analysis looks at a company’s past financial statements to predict a trend. With fundamental analysis, investors focus on the forward-looking picture and data that could impact the price of a stock (quarterly results, cash flow, and debt levels)—anything to do with the actual company.
A fundamental analysis is a lot of work, but having a comprehensive understanding of a company and its finances will give you a good idea on its financial health, products and services, and outlook. It will also help you determine whether the stock is priced fairly, undervalued, or overvalued.
Most of all, the more you learn about a company, the more confident you’ll be investing in it.
What fundamental indicators should you look for in a stock?
Look for a company that offers unique products or has a foothold in a niche market. Consider stocks that are fundamentally solid—a strong cash position, little or no long-term debt, growing revenues, ongoing profitability, and a good growth strategy. It’s also good to look for stocks that return income to investors in the form of a share repurchase program and dividends. For income-starved investors, look for stocks with a long history of not just providing regular dividends, but also a solid track record of regularly increasing their annual dividend payouts.
What Kind of Investor Are You?
What kind of investing strategy are you interested in?
Day Trading – Day trading is a short-term investing strategy where you buy and hold a stock for one or two days. Day trading is a speculative trading strategy that focuses on a technical analysis of short-term price movements to find a quick entry and exit point.
Swing Trading – Swing trading is an investing strategy that takes advantage of price movements that typically occur over three or four days. Swing trading takes more of a fundamental approach to stock trading since it can take a number of days for a stock to respond to a variety of factors.
Long-Term Trading – Long-term trading is a buy-and-hold stock trading strategy where you hold a stock for an undefined period of time. Buy-and-hold traders are not as concerned with the day-to-day market fluctuations; they take a fundamental approach to investing and understand that the markets provide a strong return over the long run. As a result, you’re not as concerned about picking the best entry point since you’ll be taking advantage of the market’s long-term growth.
Top Three Investing Strategies
There’s more to investing in the stock market than “buy low, sell high.” On one hand, the stock market is only as strong as the companies that are listed on the exchange. At the same time, the rise and fall of a share price is based on how rational or irrational investors are acting.
Being aware of different investing strategies means being able to take advantage of the stock market no matter what the sentiment is.
Stock Options – Stock options are a great way to add value to your retirement portfolio. In fact, with stock options, it doesn’t matter if it’s a bear market, bull market, or we’re trading in a range.
Stock options are one of the only investment strategies where you can protect yourself from losing money if the price of a stock falls. What’s also great about stock options is that investors can control a stock for a fraction of the price without actually owning it.
When it comes to stock options, investors bet that the price of an investment will go either higher or lower, before a certain date, then sell the investment and pocket the difference.
A stock option is a contract between two parties. By definition, a stock option buyer has the right, but not the obligation, to buy or sell the underlying stock at a specific price on or before a specific date.
When it comes to investing in the stock market and making money, no strategy is as versatile as stock option trading. That said, stock option trading can be complex and comes with inherent risks; if an investor isn’t careful, they can lose their entire investment.
Short Selling – If an investor is long on a stock, they bought a stock because they believe the price will rise in the future. If an investor is short on a stock, it means they think it will decrease in price.
While many investors think the only way to make money is when the stock market is rising, with short selling, investors can make money in a bear market, when the price of a stock is falling.
With short selling, you don’t even own the stock in question; your broker lends it to you.
For example, if you think a stock is overvalued or going to fall, you borrow the stock from your broker. The stock comes either from the brokerage’s personal inventory, from one of their clients, or from another brokerage firm.
The broker sells the shares you don’t own and credits your account. Eventually, you have to “close” the short by buying back the same number of shares and returning them to the broker.
If the price drops, you buy back the shares at the lower price and profit from the difference. If, however, the price of the stock rises, you have to buy it back at the higher price, and eat the loss.
With short selling, it’s important to be an active trader. That’s because when short selling, your profits are limited to the price of the stock. But the potential loss of short selling is, in theory, unlimited. Who knows how high it could climb?
Protective Put – A protective put is a risk-management investing strategy used to hedge or protect profits against the loss of unrealized gains. A protective put is a little like an insurance policy in that it helps lock in profits on an existing position should it experience a sudden reversal. This isn’t an uncommon occurrence, especially when it comes to Internet, natural resource, or biotech stocks
As an investing strategy, protective puts cost money, which reduces potential gains, but a protective put also reduces the risk of losing money should the security decline in value. For each 100 shares of a stock you buy, you purchase one protective put at a strike price below the current market price.
For example, if you buy a stock at $50.00 and see it quickly rise to $75.00 you might want to consider buying a protective put, since a stock can swing downward just as quickly as it moves to the upside. On top of that, you might not be able to monitor your portfolio as closely as you’d like to.
To protect your gain (or initial investment) in the above example, you’d buy one 60-day protective put contract with a strike of $70.00 for around $2.00 per contract. The entire cost of the trade is $5,200–$5,000 for 100 shares and $200.00 for the put options contract. For just $2.00 per share, you get the right to sell your stock at $73.50 for the given time period regardless of what the actual market price per share is.
If during the 60-day strike period your stock plunges to $50.00, you can do one of two things:
A) You can exercise your puts and sell the stock at $70.00. In this case, you’d keep the majority of your gain: $70.00 – $50.00 = $20.00 x 100 shares = $2,000 less $200.00 for the cost of the protective put for a gain of $1,800.
B) You could keep the stocks and sell the puts for a profit. If the current share price is $50.00 and you have the right to sell at $70.00, the actual price of your puts has probably increased in value. Selling the protective put would offset a portion of the loss on the stock and still allow you to keep your long position in the stock.
What if your stock continues to trend higher? As the stock moves higher, you’ll want to roll the put by selling the contracts and buying another one at a higher strike price. If you bought puts on your $50.00 stock at $70.00 and it climbed to $125.00, they’re no longer providing you with much downside protection. Instead, lock in your profits by rolling the puts up to a $120.00 strike.
This entails buying more puts. On top of that, renewing puts to protect your investment after the first ones expire also means buying more puts—and that will add to your costs. As long as you’re aware of the risks associated with protective puts, they can provide a solid hedge for profits on stocks with a long-term position.
Top Nine Rules for Investing
Keep It Simple – With interest rates at historic lows and the stock market offering the best returns, it’s important to know how to invest. While some analysts will tell you it takes a sophisticated understanding of the market to succeed, the fact of the matter is that it’s more important to make smart decisions. The goal is not to beat the market or time the market. Investing is about getting good returns with reasonable risk.
Do Your Due Diligence – Wall Street is not forgiving and it doesn’t give you your money back. Buy what you know. While the Internet has certainly made it easier to initiate a fundamental and technical analysis on a particular company, proper due diligence requires more than a simple Internet search. After all, most readily available information will come directly from the company—and chances are good it highlights the positive. Dig deeper. Probe regulatory actions; look for lawsuits related to the company or management team. You can also look at records to see if the company has ever filed for bankruptcy or has any criminal records. These can be important red flags that will probably be missing from the company’s public documents.
Diversify – To help offset risk, diversify your investing portfolio. That means spreading your money across different investment classes (cash, stocks, bonds). Diversifying your portfolio not only allows you to optimize returns, but it also puts you in a position to weather market fluctuations. There are excellent investing opportunities everywhere—don’t be afraid to look beyond your borders in search of the best opportunities. But don’t diversify or spread yourself too thin; concentrate on three or four sectors, or any number you can properly manage on a regular basis. That might include a mix of financials, consumer discretionary, industrials, and REITs.
Act Like an Owner – Most investors don’t actually think of themselves as part owners in the company they’re investing in, but you are. And that ownership gives the stock value. If the stock weren’t attached to the company’s performance, it wouldn’t have any value. So, act like an owner. Be proactive and keep on top of financial statements, press releases, interviews, and the like on a regular basis, weighing the competitive strengths and potential weaknesses. This will help you determine whether or not the stock is undervalued, fairly priced, or overvalued. It will also help to prevent you from impulsively buying or selling the stock.
Don’t Fall in Love With Your Stocks – Some investors have a tendency to fall in love with a stock they’ve spent a long time researching. Certain it’s undervalued, they hold onto it as it soars and refuse to sell when it plummets. Don’t fall in love with your stock. Sell if it hits your target and learn to accept a loss. It’s better to liquidate a losing stock and free up capital to invest elsewhere than hold on for dear life.
Buy Low, Sell High – As investors, we’re an irrational bunch. Ideally, we buy low and sell high, but more often than not, it seems investors buy high and sell low. Maybe it’s our fight-or-flight mentality, but investors seem to run for the exits at the wrong time. The best time to strike is when a stock is down. You’ll know it’s a good buy because you’ve done your due diligence. At the same time, it’s a good time to sell when the price has gone up! Don’t let fear get in the way when stocks fall and don’t let greed prevent you from taking profits.
Don’t Forget Precious Metals – Precious metals are a great way to hedge against economic uncertainty and inflation. Gold and silver store value as fiat (paper) currencies declines. Gold is currently mined in approximately 90 countries worldwide. Since 2001, the price of gold has increased dramatically. In addition to being held by investors, gold is also in demand for its practical uses. Gold conducts electricity, does not tarnish, and is indispensable in the areas of electronics, computers, aerospace, dentistry, medical, and glassmaking. Silver is another precious metal preferred by investors as a hedge against inflation. Silver is an excellent conductor of electricity and has a wide variety of applications. It can be found in insulation, plastics, polyester, solar panels, photography, automotives, windows and glass, medicine, nanotechnology, batteries, bearings, and electronics.
Protect Your Capital – Banks might not be providing a decent interest rate, but if you’re uncertain about the markets or can’t find anything compelling to buy, don’t be afraid to hold onto your cash, or sell your stocks and go into cash.
The Markets Always Rebound – When the markets crashed in 2008, investors of every ilk were following the crowd, running for the exits and selling great stocks for next to nothing. As an investor, it’s important to remember that the markets are cyclical. There are bear markets, bull markets, and corrections. And no matter how bad things get, the markets always rebound, as is evidenced by the market crash in 1987, 2000, and 2008—and the subsequent record highs.