NEW YORK (TheStreet) -- Today I will share with you four reasons why the market is reaching the top and two simple things you can do to improve your investing results by applying them right now. They're not complicated or difficult, or at least they shouldn't be. They're the same strategies market makers have used since the beginning of the exchanges and continue to use today.
To begin, let's examine the current market landscape we find ourselves. The Dow Jones Industrial average is near the cusp of 17,000. The Dow Jones (DIA) is widely followed by retail traders, so I'm referencing it, but most professionals gauge the market using the S&P 500. In particular, I follow the S&P 500 through the SPDR S&P 500 ETF (SPY).
The SPY is on the verge of plateauing, and it's time to take profits off the table. The market continuously cycles through 13 distinct emotions and I believe we are entering the euphoria stage. It's a market stage where investors firmly think the market will appreciate forever. Here's why you want to remain cautious when others have no fear.
Contrary to popular opinion, technical analysis isn't about predicting the future -- it's about predicting the odds.
While every investor uses technical analysis as part of their decision making (a stock chart is a form of technical analysis), few understand how truly to take advantage and exploit it for all it's worth. It's no surprise why, most don't know what they're looking at.
For example, I can listen to someone's heartbeat as well as anyone, but I'm unable to discern if the heart has a condition requiring further attention. Should I surmise listening to the heart is worthless? No, a trained doctor may hear to the same heartbeat and quickly conclude everything is fine, or the person needs to rush to the hospital.
Amazingly, many investors have reached the conclusion that it's worthless because not everyone with a few days of quick study can predict the market with 100% accuracy. Fortunately, the medical profession takes a different view on the amount of training required.
The above chart represents the SPY using monthly bars. I've circled and placed a white arrow under the bar of importance. It's a modified DeMark indicator representing an area that may reach an exhaustion point. Alone, it's not enough to sell and or short the market. However, I've found when combined with other time periods, they become useful in my market timing.
One of the most accurate market timing tools I have is the combination of a monthly or weekly chart with a 13 followed by the same with the daily. Tuesday, the daily made a 12, and if Wednesday closes at a new high, it will become a 13.
It doesn't mean with certainty this week will mark the high before a significant correction occurs, albeit for investors who operate like a casino, allocating capital based on the odds, it means it's time for profit taking. Simply stated, the odds are increasingly favoring an overall market correction based on the market timing tools I use, including the above charts.
This brings us to the first simple thing you can do to improve your portfolio results. Leave your emotions outside when making financial decisions. Logic is a great decision maker, emotions are not. Don't fall into the euphoria trap.
We all have that neighbor bragging about how much money they're making in stocks. They didn't have much to say in 2008 and 2009, but now they are experts. They focus on how much money they can make, and give little or no thought to the amount of risk they're exposed to. Never think in terms of how much you can make, always keep your eye on your capital and its preservation.
Earnings season arrives next week. Nothing else moves the overall market as rapidly and decisively as earnings season. Alcoa (AA) and Wells Fargo & Company (WFC) are the two most widely watched companies reporting. In front of last quarter's earnings season, I wrote How to Make Coin on JPMorgan and Wells Fargo Into Earnings. Wells Fargo's shares have performed great over the last year.
I maintain that Wells Fargo is best in class and a great bank to own. However, during my examination for its upcoming earnings I found the stock chart technical pattern similar to SPY insofar as reaching an overbought area likely to experience a retracement lower.
Macquarie appears to agree. On June 30 the analyst downgraded Wells Fargo from a neutral rating to underperform. That said, 13 out of 29 analysts I track rate the company a buy, and 14 have given it a hold rating.
In a nutshell, earnings season is always volatile, and two key stocks starting this quarter's reporting are trading near 52 week highs. If others' profit taking catches you by surprise, you're not paying attention.
Interest rates are expected to rise soon. Historically record low interest rates have created an environment where investors have few choices other than the stock market for yield. For many student loans interest rates increased this month. That means less money spent at retail and more money for lenders.
It's no secret the Fed is slowing the rate it's refilling the punchbowl, and an improving economy will result in higher yields in non-equities. We're already witnessing Treasury bond traders positioning for higher interest rates. Traders are betting the Bank of England will raise its benchmark rate in early 2015, followed by the Fed later in the year.
A growing economy may appear intuitively positive for the stock market, and indeed, in typical non-manipulated times, it would. However, the current below market interest rates have distorted the market to the upside. Investors should expect a reversion to the mean as the Fed pulls away, and rates rise because capital will flow out of equities and into bonds and other investments.
New York Stock Exchange margin debt is near record highs and over $400 billion. Margin debt is a measurement of how much borrowing investors are using to buy the shares they own. The first chart illustrates the emotional rollercoaster investors experience and its impact on stock prices.
Unsurprisingly, the market tends to spike at the same time investors are using the most margin to purchase stock. Or, another way to view it is investor confidence drives more margin as the market climbs.
Margin debt is off the February highs, but this is the first time the debt level has remained above $400 billion several months in a row. The last time the margin debt level exceeded $400 billion was during the spring and summer of 2007. After quickly falling (along with the market), margin debt reached a multi-year low at the beginning of 2009.
In other words, investors used the most debt at exact time they shouldn't have, and used the least amount of debt at the precise moment they should have backed up the truck and bought as much as they could.
Moving back in time, the last margin debt peak occurred at the start of 2000, just as the dot com bubble was bursting. It bottomed in 2002, right at the bottom of the SPY. Margin debt is one of the most accurate indicators for long-term investing, and it may have once again peaked.
Individually, each market indicator is interesting, but not necessarily convincing. Taken in combination, they are warning signs investors are well advised to pay particular attention to. The market doesn't warn investors ahead of time with an email or neon sign that it has peaked.
It does however leave clues that smart investors can use. It's up to you to decide. This leads us to the second simple thing investors can do to increase their portfolio performance. Invest like a casino. Only expose your capital when you have the best of it and the odds are in your favor. That means never hoping and never having too much exposure in any given stock.
At the time of publication, Weinstein had no positions in securities mentioned.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.
TheStreet Ratings team rates ALCOA INC as a Hold with a ratings score of C. TheStreet Ratings Team has this to say about their recommendation:
"We rate ALCOA INC (AA) a HOLD. The primary factors that have impacted our rating are mixed ? some indicating strength, some showing weaknesses, with little evidence to justify the expectation of either a positive or negative performance for this stock relative to most other stocks. Among the primary strengths of the company is its solid stock price performance. At the same time, however, we also find weaknesses including deteriorating net income, disappointing return on equity and weak operating cash flow."
Highlights from the analysis by TheStreet Ratings Team goes as follows:
- Compared to its closing price of one year ago, AA's share price has jumped by 92.77%, exceeding the performance of the broader market during that same time frame. Although AA had significant growth over the past year, our hold rating indicates that we do not recommend additional investment in this stock at the current time.
- AA, with its decline in revenue, underperformed when compared the industry average of 4.4%. Since the same quarter one year prior, revenues slightly dropped by 6.5%. Weakness in the company's revenue seems to have hurt the bottom line, decreasing earnings per share.
- ALCOA INC has experienced a steep decline in earnings per share in the most recent quarter in comparison to its performance from the same quarter a year ago. The company has reported a trend of declining earnings per share over the past two years. However, the consensus estimate suggests that this trend should reverse in the coming year. During the past fiscal year, ALCOA INC swung to a loss, reporting -$2.15 versus $0.17 in the prior year. This year, the market expects an improvement in earnings ($0.45 versus -$2.15).
- Return on equity has greatly decreased when compared to its ROE from the same quarter one year prior. This is a signal of major weakness within the corporation. Compared to other companies in the Metals & Mining industry and the overall market, ALCOA INC's return on equity significantly trails that of both the industry average and the S&P 500.
- The company, on the basis of change in net income from the same quarter one year ago, has significantly underperformed when compared to that of the S&P 500 and the Metals & Mining industry. The net income has significantly decreased by 219.5% when compared to the same quarter one year ago, falling from $149.00 million to -$178.00 million.
- You can view the full analysis from the report here: AA Ratings Report