Outside the Box: Understanding the Key Fundamental Broad Market Factors
January 30, 2008
these volatile times of rapidly changing markets, it is tough to determine what really is normal. When it comes to buying stocks, professional investors rely on four fundamental market factors before they make their decisions based on a definite plan. They consider the overall health of the market by weighing these key determinants.
The overall market value factor relates to the prices of shares to earnings, dividends, and replacement value. It also considers earnings in relation to short-term and long-term bond yields. Market values are very good when a bull market begins. When stock prices increase significantly over a long period, the values aren’t as good as they were.
The current economic trend also plays a key role. It’s important to know whether the economy is so overheated that borrowers will have difficulty finding cash at affordable rates or so dampened that the lowering of interest rates is likely. The stimulus of lower interest rates is good for the market, but a tight money environment is bad.
In addition, keeping a pulse on the latest monetary activities is important. Bond and stock markets usually perform best when the money supply is rising, and they get into trouble in periods of monetary contraction. If the money supply contracts drastically, as it did in the 1930s, it can be disastrous for investors.
The next areas that need to be closely analyzed are the technical factors present in the market. Within the technical arena we need to look at some of the various sub-categories to get an overall feel for these major influences. First would be sentiment, which is the measurement of how people feel about a particular type of investment. If investors generally feel optimistic, the overall market sentiment is bullish and that’s bad. The market is safest when the prevailing sentiment is gloomy and pessimistic. For instance, when there is great optimism and lots of positive headlines, stocks tend to trade at a premium.
Market Breadth is another technical attribute that must be considered. Market Breadth can be more significant than the movement of an index of that investment, because it shows what is happening to all individuals of that type, rather than just the high-grade ones. Historically, an increase in an investment market’s breadth has been a good sign in a rising market.
And finally markets have cycles, that is, they have long periods when they go up, then they go sideways, and then they go down. So you must measure what they are currently doing by tracking what is called a moving average. The moving average is a measure of whether an investment conforms to a certain trend or is about to break out of an existing trend.
With stocks, for instance, a 50-day moving average is the sum of the past 50 days’ closing prices divided by 50. To create an ongoing 50-day moving average, every day we would drop the 50th day back and add today’s new closing prices. Follow this procedure on subsequent days.
If the stock price falls below the moving average, this is considered negative. If it rises, it’s considered positive. To chart the long-term effect, use a 200-day moving average. Some investors always buy when an index first crosses above the long-term moving average and sell when it crosses below the moving average.
As experienced investors know, there are no hard and fast rules about the right mix of asset classes to hold in your portfolio. Nor are there set standards to tell you when to change the mix. However, as outlined in this article, there are certain rules of thumb that suggest the courses of action you should take or not take in different economic and market climates.
Happy Trading.
Jeff Neal
Senior Writer, Options Strategist & Profit Strategies Radio Show Market Correspondent
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