November 5th, 2010

Avoiding the Next Bubble

Although everyone is ebullient about the market’s success in making a new 52-week high, I’m adopting an unusual and somewhat uncomfortable stance. I’m going to assume the role of “contrarian” and throw out some caution.

I was as ecstatic as anyone yesterday watching all those green numbers flashing on my computer screen. But have you ever taken a look at the longer-term charts of some of the leading stocks many of which are also on the IBD 100 list? As you scroll through a stack of them, you’ll feel like you’re watching fireworks going off on the Fourth of July. The prices of many leading stocks have doubled, tripled and some have even gone up five-fold since Labor Day 2009. Here are a few examples (click on image to enlarge):

  • APKT (stock has run up over five-fold since Sept 1, 2009 when it was in the midst of forming its previous consolidation pattern. It’s to early to say what the recent movement is carving out, whether consolidation or reversal with the market’s future course probably being the deciding factor).
  • IGTE (has run up without any significant consolidation since its March 2009 low under $2; one is definitely overdue.)

Oh, if we had only had the foresight …. and the courage ….. to put our money into these stocks and a raft of other momentum stocks rather than watching a stagnant S&P 500 struggling for a year to break free of its consolidation trading range! If we only had hindsight! But we didn’t because no one can predict the future. All we can do is to find indicators that give us some warnings about what the future might hold and then, if the events materialize, we try to react appropriately.

A few days ago, I wrote in “IBD and Market Timing? I Don’t Think So” about the Market Security Meter. The market timing indicator did properly indicate that the best strategy was to exit the market in January 2008 and then reenter in June 2009, however, those calls confirmed, on the one hand, the market’s damaged and weak condition and, on the other hand, its full recovery.

Looking closely at the IBD 100 chart in the posting referenced above, it appears that the IBD 100 index peaked ahead of the general market as measured by the S&P 500. Perhaps if we focused on today’s market leaders and try to discern when they turn weak and roll over, that could serve as an early warning to approaching weakness in the broader market?

Towards that end I created what I call the “Bubble-30 Index”, an index composed of 30 of today’s leading momentum stocks including names like Priceline (PCLN), Netflix (NFLX), Chipolte (CMG). The list crosses many industry groups and includes several international stocks. When demand for these stocks dry up and the money flow reverses direction, this Index should send an alarm of an impending change in market sentiment.

Here’s what the indicator looked like last night (click on image to enlarge):

Greenspan warned on “irrational exuberance” back in 1996 but no one listened to and soon forgot his warning because stocks continued to run. If we had our eyes focused on the Bubble-30 Index of that day, confirmed by the Market Security Meter, perhaps we would have not been devastated in the Tech Bubble Crash.

The Bubble-30 Index, along with current readings of the Market Security Meter, are tools included in the Weekly Recap part of the Instant Alerts subscription.

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