This is the fifth in a series of posts where we're looking at gauging the stock market's direction.
If you would like to know more, please just download our free report How to Gauge Stock Market Direction.
Did you know that the market indexes always eventually move into higher ground? Sometimes they do move sideways for very long periods (a decade or more) but eventually they always break into new high ground. The most popular market index in the UK is the FTSE 100, which you are probably familiar with but have you heard of the S&P 500? The FTSE 100 is an index that contains the hundred largest publicly traded companies in the UK and the S&P 500 is the United States equivalent, and contains five hundred of the largest US businesses.
As you can see from the illustration, the long-term trend that the S&P 500 has formed is up. Look closely and you’ll notice that the chart features grey vertical shaded areas and these represent the bear markets. The white areas on this chart are the bull markets.
If you take another look, you’ll also notice that apart from the two most recent bear markets, the market has always recovered after significant correction periods and proceeded to move into new higher ground. This means that, at some point in the future, indexes such as the S&P 500 will eventually make new highs, far and above the highs made on October 11th 2007, when it topped out at 1,576.09. In fact, as we write this*, it’s currently trading at 2021, 28.2% above its October 2007 high*.
* Reading taken Tuesday February 3rd 2015.
The market works in cycles
Bull markets last between two and four years. Bear markets last approximately nine to eighteen months. Because bull markets last longer, the stock market over the long term forms an uptrend. In a typical cycle, you’d normally have three years up and then one year down. The bull/bear cycle then starts again and keeps repeating.
Bear markets tend to end when businesses and the economy are still in a downturn and bull markets often end way before a recession sets in and usually when all the business and economic data looks positive. The market’s action is determined by millions of investors and its daily activity is a result of the investors’ general consensus about what they like or don’t like and what they foresee happening in the world. For example, what governments are doing or about to do and what the consequences of those actions could be.
Make money by asking the audience
Rather than trying to work out where the market is likely to head by reading reams of economic data, reading the newspaper or listening to the latest financial news, we would rather see what institutional investors think and more importantly, closely watch what they are doing. We can very easily see what they are thinking by looking at charts. We can tell if they are bullish and aggressively buying stock or if they are bearish and aggressively selling.
Each and every day we simply analyse what has happened and what it means. We look to see if it is positive, neutral or negative. If, over several weeks, the activity is positive, it would tell you that the market is behaving well and therefore more likely to head north than south. If, however, the behaviour is negative, it would suggest that the market is more likely to head south.
How to analyse the market’s health
Institutions, not individuals, account for nearly 75% of the daily trading activity on the exchanges**. That’s why it’s important to watch their activity carefully. The large institutional investors have the greatest influence on the stock market and consist of investment funds, banks, pension funds and insurance companies.
If these 800lb gorilla investors are buying, smaller, more nimble investors like you and us can jump onto their coat-tails. And if these institutional investors are selling, you could quickly switch out on to the sidelines. Here is how it works. Picture the market as a large tree and try to imagine institutional investors being woodcutters. If institutional investors are selling heavily it is as if they are taking a cut out of the tree and this of course, makes the tree weaker.
If they take too many swipes at the tree in a short space of time, what is going to happen? That’s right, the tree will fall over. This means that the market gets weak when it succumbs to excessive selling, which results in a red flag being raised. When heavy selling occurs, especially over a short period of time, it’s often a sign to say that it’s probably the time to get out of the market. On the other hand, when institutional investors are buying heavily over a short period of time, it makes the market healthy and extremely strong, and this is the time we like to be invested.
In the next post in this series, we'll look at how to analyse the market's health by watching price and volume action.
Remember, if you would like to know more, please just download our free report How to Gauge Stock Market Direction.
As always, if you have any questions or thoughts on the points covered in this post, please leave a comment below or connect with us @ISACO_ on Twitter.
ISACO specialises in ISA and SIPP Investment and is the pioneer of ‘Shadow Investment’; a unique service that allows you to look over our shoulder and buy the same funds that we are buying. Together with our clients, we have an estimated £57 million actively invested in ISAs and pensions***. Clients like us because we have a track record of ‘beating’ the FTSE 100****. Over the last 17 years, we’ve outperformed the Footsie by 77.9%. You can find us at www.ISACO.co.uk.
What is Shadow Investment?
Picking the right fund for your ISA and SIPP is not exactly the easiest job in the world. And knowing 'when' to buy and 'when' to exit is even more difficult! Our ‘Shadow Investment’ Service is here to help. Our service allows you to look over our shoulder and buy the same funds that we are buying.
When we are thinking of buying a fund, we alert you so that you have the opportunity to buy it on the same day that we buy it. We also tell you about when we are planning to exit the fund. You control your investment account, not us. You can start small and invest as little or as much money as you like.
By knowing what we are buying, when we are buying and when we are exiting, throughout the year you can mirror our movements and in effect replicate our trades. This means you have the opportunity to benefit from exactly the same investment returns that we get. Our investment aims are 8–10% per year.
We are totally independent, fully transparent and FCA compliant. We’re warm, friendly and highly responsive and it’s a very personal service that gives you direct access to the Sutherland brothers; ISACO’s two founders.
Who are ISACO’s clients?
Clients who benefit most from our service have over £250,000 actively invested and the majority of them are wealthy retirees, business owners, self-employed professionals and corporate executives. We also have clients from the financial services sector, such as IFAs and wealth managers.
Do you have questions?
To have all your questions answered, call 0800 170 7750 or email us at: info@ISACO.co.uk.
*** November 15th 2012: Internal estimation of total ISA and pension assets owned by ISACO Investment Team and ISACO premium clients.
**** December 31st 1997 - December 31st 2014 ISACO 105.5%, FTSE 100 27.6%. ISACO Investment performance verified by Independent Executives Ltd.