When Too Many People Know It’s
a Good Thing: Time to Get Cautious

stock market cautionThe stock market has been up six consecutive trading days in a row, with the bellwether Dow Jones Industrial Average up about three percent last week. The secret is out: the economy is getting better, companies are making money again, and stocks are not a bad investment anymore.

While I have been bullish on stocks through most of 2009 and 2010, I want to remind my readers that not a single investment goes up or down in a straight line. If we look at the Dow Jones, it’s actually up 14% since the end of August. I’m warning my readers to tread carefully here.

The more investors start to pay attention to the stock market, the more likely a price correction will take place. In this case, and at this particular point in the rally, a stock market correction would actually be healthy for stocks, as they have risen too quickly in too short of a time frame.

Let’s face the facts:

Advertisement

Interest rates in the U.S. are not going up anytime soon. Retailers look like they are going to have a whammy of a December holiday seasons in terms of cash registers ringing. Corporate profits have been rising across the board. Stocks are a great alternative to the bubble in the bond market.

Hence, there is more life left in the bear market rally that was born on March 9, 2009. Stocks can and will move higher. But caution is advised, because stocks have been getting a little too ahead of themselves. Stick with good-quality growth companies. (I don’t buy a stock unless I look at its price chart; neither should you.)

Heading into 2011, the picture gets foggier. The U.S. dollar sits this morning near a record low against a basket of other major world currencies. I keep asking myself: how long will foreigners buy the bonds the U.S. so desperately needs to sell to fund its debt-drunken politicians?

Let’s look at it this way: I’m a guy in Canada. I bought $100,000 of U.S. bonds last year at this time and it cost me $105,000 Canadian. When I go sell those bonds today, because the U.S. dollar has fallen against the Canadian dollar, I just get back $100,000. I lost $5,000 and the interest payments on the bonds hardly made a dent in my loss. Why would I keep buying U.S. bonds? At a certain point, I won’t unless I’m paid more interest on the U.S. bonds I buy.

Late last week, former Federal Reserve Chairman Paul Volcker (the guy who brought us 20% interest rates in the early 1980s) said that the Fed’s recent Quantitative Easing Part II act could cause inflation down the road. No kidding. With so much money in the system, higher inflation is inevitable. So are higher interest rates. And this is why we have to worry about the stock market in 2011.

Michael’s Personal Notes:

You need to give credit where credit is due, and I certainly give credit to Ford Motor Co. (NYSE/F).

When Chrysler and General Motors Co. got into trouble during the Great Recession and ran to the government for money, they both ended up in bankruptcy. Yes, Ford had difficult times like everyone else in the car business. But they never went to the government for money; they never restructured.

As a lifelong entrepreneur, I can tell you that most businesses fail when they are passed down to the second and third generation. Ford is a rare exception to this rule.

Ford is the second largest U.S. automaker. Its October sales were up 15%. Third-quarter net income was $1.7 billion—the most Ford has ever made in a quarter during its 100-plus years in business. The company sits with over $20.0 billion in the bank, it has obviously won market share from Chrysler and General Motors, and its brand is strong. Its stock price is stronger—now at a six-year high.

When they ever get around to changing the business books at those MBA programs, Ford Motor needs to the case study all MBA grads undertake.

Where the Market Stands, Where It’s Headed:

The Dow Jones Industrial Average opens this morning up 9.7% for 2010. The bear market rally that started in March 2009 is alive and well.

What He Said:

“If I had to pick one stock exchange that would rank as the best performer of 2007, it would be the TSX (Canada’s equivalent of the NYSE). Interest rates in Canada remain very low and they are not expected to rise anytime soon. Americans looking to diversify their portfolios, both as a hedge against the U.S. dollar and a play on gold bullion’s price rise, should consider the TSX. Most brokers in the U.S. can buy stock on this exchange.” Michael Lombardi in PROFIT CONFIDENTIAL, February 8, 2007. The TSX was one of the top-performing stock markets in 2007, up just under 20% for the year.