Market Update 12/23/13

December 23, 2013
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By Michael Cintolo, Analyst of Cabot Market Letter

As the very profitable year of 2013 draws to a close, these thoughts are uppermost in our minds.

As the year started, optimists were hard to find. The drama of the Fiscal Cliff dominated the news, and the market had given us two very frustrating choppy years. But the market soared at the start of the year, and motored higher persistently all year, and eventually, the news did get better. But those who delayed investing until the news was good missed much of the advance.

More recently, the Fed announced—finally—that it would begin tapering, reducing its program of economic stimulus. For months—even years—investors had been dreading this day, because historically, tighter money means weaker markets. But the market surged in response, climbing 2% to record highs, reminding us that bad news well anticipated is not bad news at all. And if it’s not as bad as anticipated, it’s good news!

So now here we are, near the end of a very profitable year, with fatter portfolios and fewer worries. Unemployment is down, manufacturing is booming, our representatives in Washington managed to compromise on a budget near year-end, and militarily, prospects for conflict are smaller than at the start of the year.

Most important of all (and least respected) is the fact that investors are far more optimistic than they were a year ago. This worries us, and it should worry you, too.  The old Wall Street axiom is that bull markets climb a wall of worry. The latest advance illustrated that perfectly, and even fit neatly into the calendar year. But today, with optimism  widespread, and institutions widely invested in leading stocks, the question is, “Is there enough money on the sidelines to push this market even higher, or do we need a correction before the advance can resume?”

Even bigger—more academic—is the question of whether we have truly left behind the secular bear market of the past 13 years and embarked on a new secular bull market. If so, the next correction is likely to be mild. But if not, it’s likely to hurt.

Those are big questions, and the fact is, we don’t know the answers. No one does. But we don’t need to know the answers to be successful investors. We just need to have a working system that we trust, and happily, we do.

In recent months, the two trend-following components of our system have kept us bullish, while the Two-Second Indicator has been warning that the broad market has weakened. We’ve known that part of that warning signal is due to the selling of interest rate-sensitive closed-end funds, and it will be interesting to see if that continues into the New Year—and whether a multiyear trend towards rising rates, and thus falling bond prices, dooms the indicator to a long period of false warnings.

Regardless, we’re confident that our system won’t let us down. We know the year ahead will bring many surprises, and we know that investors who buy into this bull market at the top will be hurt (they always are), but we know that in the long run, our system will keep you on the right side of the market most of the time—and in the right stocks—and that’s all you need to be a successful investor!

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