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The objective of this
article is to illustrate a powerful investment analysis technique by first
examining a simplified hypothetical scenario. We will then explore this
concept on the markets of today. To do this we will:
1) Outline some basic investing rules to be used as
guidelines.
2) Present a hypothetical scenario for analysis.
3) Guided by our rules, form a conclusion for the
purpose of understanding the markets.
4) Explain how we think this analysis applies to the
markets of today.
1) Rules to guide investment analysis:
A. All markets are cyclical.
No investment is constantly a good or a bad investment. Where a
particular investment is in its cycle is what is critical.
B. There is always a bull market somewhere. When one investment class is at an extreme high,
we believe there is always an investment at an extreme low. The trick
is to invest in the investment class which buys the most of that asset for
the least amount of money.
C. All major macro market trends will not end until
an extreme is reached in the direction traveled. Once that extreme is met, like
a pendulum swinging, the new trend will start and will not end until the
extreme is met in the other direction. Bull markets start when public
sentiment towards an investment is extremely pessimistic following a major
bear market and end during extreme public optimism.
2) Hypothetical Scenario for Analysis:
For
this hypothetical scenario we ask the reader to ignore previous investment
understandings and simply concentrate on the word problem below:
For
this scenario assume there are only four major investment classes: Stocks, Bonds, Real-estate and Commodities. It is the year 2000 and
as a general rule:
a) Stocks have been in a bull market for about twenty years,
and public sentiment appears to be at an extreme high.
b) Bonds have been in a bull market for about twenty years,
and public sentiment appears to be at an extreme high.
c) Real-estate has been in a bull for about
ten years and public sentiment appears to be aggressively climbing.
d) Commodities have been in a bear market for
about twenty years and public sentiment appears to be at an extreme low.
QUESTION:
Based
on the rules in section one of this article, of the four investment classes
outlined in this scenario, what investment is most likely to be starting a
brand new, long term bull market?
3) Hypothetical Scenario Conclusion
ANSWER:
The
answer is obviously (d) commodities. If we consider the above rules we
know that all markets are cyclical and Stocks and Bonds are likely at the end
of their bull market after a twenty year climb while public sentiment is at
an extreme high. We also know real-estate is heading into its more
aggressive growth phase as public enthusiasm picks up steam. However,
considering our rule that bull markets are cyclical, the real-estate market
is likely maturing rather than starting at an extreme low. Finally,
commodities have been in a major bear market for twenty years. This
asset class is practically hated as an investment opportunity and as a result
ready to start a new long term bull market.
You may
be wondering, since we are in the year 2007 and not 2000, how does this
hypothetical scenario apply to our understanding of the markets today?
4) Understanding the Markets Today
The
answer to that question is simple. The same rules expressed above can
be applied to the markets of today. Why? Human behavior as a group is very predictable. Individuals
can be unique but given a certain set of circumstances people as a collective
will behave in a predictable manner. If a group of people outside are
rained on, most will seek cover from the rain. Some individuals may
enjoy the rain but most will predictably seek shelter. When dealing
with an emotional topic such as money and finances this predictability is
especially true. For example, if an investment is rising in value our
excitement and greed tends to make us want to buy more. As a group we
bid prices up until they are too high, the extreme is then met and the trend
quickly corrects. We believe this is the predictable behavior of markets.
So if
we apply the rules above to the markets of today how can we profit from this
knowledge when we invest? We know that since 2000 until now:
a) Stocks had a major correction starting in 2000 and
have since bounced. However, public sentiment has remained high.
We believe brand new long term bull markets do not typically start in these
conditions. Additionally, in our opinion it is highly unusual for a
major twenty year bull market to end and then start with only a two year
correction in between. This is not nearly enough time for public
sentiment to diminish and set the ground for a new prolonged bull market.
b) Bonds typically follow the same pattern as stocks and
in our opinion bonds are in the same situation as stocks in this scenario.
c) Real-estate by our calculation hit an extreme high in price,
public optimism, excitement etc. The indicators of the publics extreme
"can't lose mentality" towards real-estate are simply too many to
list in this article. Recently we have witnessed a correction, however
in our opinion this is not nearly enough of a correction to offset the
imbalance of the massive bull market advance.
d) Commodities have been in a bull market for about four
to six years depending on how one determines the bottom. We believe
overall public sentiment towards commodities remains negative but awareness
of this market is very slowly making it to the consciousness of the general
public. In our opinion this is extremely bullish for commodities.
The market is rising yet it seems most investors are not aware of the potential
mega bull market.
In our
opinion the commodities bull market is just getting started. As the
general public realizes the commodities bull has been roaring ahead, they
will likely jump on board and push up prices to dizzying, unsustainable heights.
We think commodities are a long way from being overvalued and the time to
invest in commodities is before the public becomes aware of this mega trend.
We believe fortunes will be made in this bull market as early comers grow
their wealth and late comers try to catch the trend, but fortunes will be
lost for those who overstay their welcome.
Having
a set of rules, understanding market behavior and
incorporating a trading system around these principles helps an investor
ignore the day to day noise and misinformation of media hype. Having a
system helps an investor reduce common investor weaknesses such as emotional
trading decisions.
We
encourage readers who enjoyed this common sense approach to the markets to
visit our website at www.investmentscore.com. Here you will find free
commentary, learn about our unique system for investing in the markets and
have the opportunity to subscribe to our free newsletter. You may also
learn how we plan to determine when we will sell our precious metals
investments.
Michael Kilbach
Editor
Investmentscore.com
Michel Kilbach is
the President and Editor or www.investmentscore.com, an online publication designed to
show investors how to make profitable entry and exit trading decisions in
high growth potential investments. Investmentscore
uses a unique scoring system as a visual guide to assist investors in making
lower risk / higher reward trades.
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Copyright © 2006-2007 Michael Kilbach
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