Sunday, May 20, 2012

Buy Some Stocks This Week

While valuation is the most important determinant of long-term returns from the stock market, sentiment and technical measures drive shorter-term returns.  These two shorter-term indicators of the stock market give reasons for optimism. 

The abrupt decline in stock prices over the last two weeks has caused sentiment measures to turn sharply from widespread optimism to pessimism.  The AAIA survey of individual investors, for example, now shows twice as many pessimists as optimists, which usually indicates a good time to buy stocks.  Other, proprietary measures, show similar pessimism that is historically associated with subsequent gains in stock prices.

Similarly, on a technical basis, stock indexes have fallen rather sharply, and particular individual stocks have had dramatic declines (one of my favorites has fallen 22% in about two weeks).  The 14-day relative strength index for the S & P 500 is below 25, which has tended to indicate an oversold market that would be due for at least a bounce.

For some time I have advocated maintaining above-average levels of cash reserves.  I'd use some of that cash this week to buy stocks in the U.S.  European stocks have been hit especially hard and offer long-term value, but I would wait for even better valuations there before making large purchases.

Steve Lehman

S & P 500:  1295

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