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Before You Invest One Red Cent
By: James Brumley   Sunday, July 15, 2007 10:15 PM
The market can and does fall, sometimes for months at a time. If you insist on holding stocks in defiance of significant downtrends, just be prepared for disappointment.


The Economy Isnt The Market


Although advisors and brokerage firms seem to have economic data piped in by the truckload, theres very little evidence of any correlation between the economys strength or weakness and the markets strength or weakness. The majority of analysts would - and will - argue this point. Fine. Just be sure to ask them for their research that shows the connection between interest rates and stocks over the long-haul (month). Its not there. The fact is, the economic cycle and the market cycle are not synchronized in a way that any investor could consistently rely on. Take a look at the seven most recent rising rate environment, and the effect it had on stocks. It wasnt nearly as bearish as it was supposed to be.

  • Feb. 72 to July 74: The Fed Funds rate rises from 3.3 to 12.9. The S&P 500 moved from 106.57 to 79.30. The market lost 25.5% during that time.
  • Jan. 77 to June 81: The Fed Funds rate moves from 4.6 to an all-time (modern era) high of 19.10. The S&P 500 moved from 102.2 to 131.21. That's a 28.3% gain.
  • Feb. 83 to Aug. 84: The Fed Funds rate moves from 8.5 to 11.6. The S&P 500 moved from 148.05 to 166.67. That gain totaled 12.6%.
  • Oct. 86 to March 89: The Fed Funds rate rises from 5.8 to 9.8. The S&P 500 went from 243.97 to 294.87 (and this includes the 87 crash). The market gained a net of 20.8% here, despite the 24% loss suffered over October 16th and 17th of 1987.
  • Dec. 92 to April 95: The Fed Funds rate moves from 2.9 to 6.0. The S&P 500 rose from 435.70 to 514.70. That was an 18.1% gain.
  • Jan. 99 to July 00: The Fed Funds rate moves from 4.6 to 6.5. The S&P 500 moved from 1279.63 to 1430.85. That's a gain of 11.8%, even though it includes the very beginning of a huge bear market.
  • July 03 to mid-2006: The Fed Funds rate rose from 1.0 to 5.25. The S&P 500 has risen from 990.30 to 1280. That's a market gain of 29.3%, and still counting.

Surprisingly, many advisors would still argue the point despite these facts. As an investor, you cant afford to ignore them. You will, however, need an enormous amount of willpower as well as thick skin to trust the facts when all you get from the media is unfounded opinion.


Never Confuse a Company with Its Stock


Many years ago, logic prevailed in the market. Good companies were transparent, and their stock price basically reflected the value of the corporation. Times have changed dramatically, and probably permanently. Now, good companies may make tons of money, while the stock sinks like a rock. Remember, as an investor, you only make money if your shares move higher. The only thing that makes a share move higher is more buyers than sellers. If nobody wants the stock of a great company (and yes, it happens more than you might think), its shares are not going to appreciate in value.

For that reason, its imperative to analyze charts as well as fundamentals. Charts can tell you what a stock is likely to do in the near future, while consistent fundamentals tell you how that same companys stock is likely to behave in the distant future. Both the technicals and the fundamentals should be part of a prudent stock-picking plan.

Keep in mind that most advisors have either adopted one methodology, or the other. In general, theyve sworn off the other philosophy as hogwash. Most books are also just written form one perspective or another, but again, thats a mistake. Use both tools to the best of your ability.


Epilogue


Over the next several weeks, well be adding a lot of details to this two-pronged stock-picking approach. Some you may agree with, and some you may not. Thats fine, as long as you understand and can explain the reason you may disagree with an idea. Nobody owns the corner when it comes to investing knowledge. Continually learn, and constantly question any advice you get. Its your money, and nobody has a bigger interest in growing and protecting it than you do.

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