How to Invest in this Market

Ian Wyatt — Wed, 29 Sep 2010 16:03:00 GMT

In difficult economic environments, when the stock market seems to move with little rhyme or reason, investors will sometimes say "it's a stock pickers market."

The idea of a "stock picker's market" is that of a trendless market, but one where you can still buy quality, undervalued stocks and make money.

But according to the Wall Street Journal, that's not what we have right now. And investors who are relying simply on a company's fundamentals to invest are not being rewarded with profits.

That's because these days, stocks tend to move in tandem in response to macro forces, like the economic news, politics or regulations.

It's called correlation when stocks move with the S&P 500. Between 2000 and 2006, correlation with the S&P 500 was 27%. That means that most stocks moved independently of the S&P 500. Today, correlation is around 66%, and has been as high as 80% in the last year.

The fact that the majority of stocks move together tells us a couple important things. One, investors are using Exchange Traded Funds (ETFs). ETFs, which are baskets of stocks representing a particular sector, give investors a less risky to capitalize on sector trends.

So, for instance, if technology is doing well (which it is), instead of trying to invest in one particular company, an investor might buy the Semiconductor HOLDRS (SMH) and get broad exposure to chip stocks like Intel (Nasdaq:INTC), Altera (Nasdaq:ALTR) and Broadcom (Nasdaq:BRCM). Or they might choose the Software HOLDRS (SWH) and get exposure to Microsoft (Nasdaq:MSFT), Oracle (Nasdaq:ORCL), Intuit (Nasdaq:INTU) and TIBCO (Nasdaq:TIBX) among others.

When investors buy ETFs, the funds have to go out and buy stocks, which helps cause higher correlation.

High correlation of stocks also tells us that investors are still very nervous about the U.S. and the global economy. When good economic data is released, we usually see a powerful rally. Conversely, a weak unemployment report or news about inflation in China can send all stocks lower, regardless of their fundamentals.

Now, how can we use this information? For one, it suggests that taking a trader's mentality and buy the dips and sell the rips. My colleague at Wyatt Investment Research, Jason Cimpl, who runs the TradeMaster Daily Stock Alerts service has led his subscribers to 146% cumulative gains this year with his swing trading strategies.

We can also accumulate quality stocks when they sell off. Because the current high-correlation environment won't last. Investors will get more comfortable that the U.S. economy isn't going to fall apart again like it did in 2007-2008. That will lead some more stability for the stock market as investors won't run for the exits every time some thing goes "bump" in the night.

I would also recommend focusing on sectors that will benefit from growth, like financials and energy.

Monday's late sell-off was a bit disappointing after the blockbuster rally on Friday. It's always nice to see some follow-through after a rally.

But volume on the S&P 500 was lighter Monday than it was on Friday, which is positive. And the index is still well above support at 1,130.

The S&P 500 has tested resistance at 1,150 twice during this rally. I still expect it to break above that level.

For your information, Fisher Investments CEO Ken Fisher told a Forbes roundtable that "...[t]he next 10 years are going to be just as good as the 1990s. The problems in this current environment we think are so different, and so new and so unique. It's the same stupid old normal we've always had. We've got a great future."

By "stupid old normal" he's referring to the PIMCO idea of a New Normal, where growth remains very slow and unemployment high. Fisher pointedly called the New Normal, as championed by PIMCO's CEO Mohamed El-Erian, "idiotic".

Of course, I'd like to hear your thoughts here: ianwyatt@wyattresearch.com

Daily Profit : S&P 500, PIMCO, TradeMaster

How to Invest in this Market