Why the Stock Market Boom is on Pause

By MoneyMorning.com.au

We had lunch with a couple of old broker pals yesterday. The broad opinion was that we were all worried that the stock market was heading for a fall.

But not the whole stock market, just one bunch of stocks in particular.

Trouble is those bunch of stocks happen to make up a big percentage of the market. We’re talking about dividend stocks.

As one of our lunch pals said, ‘It’s hard to recommend [Commonwealth Bank] when it’s trading near $70.’

However, just because a market or stock hits a new high, it doesn’t mean it will fall straight away. That’s because there’s one key factor you can’t ignore – the Reserve Bank of Australia (RBA).

As long as the RBA keeps interest rates low it will be difficult for investors to sell stocks yielding 5% or 6% in favour of bank deposits paying 3% or 4%.

So how long could this last? This is where we can look to the US for an insight. Here’s a chart of the Dow Jones Industrial Average that this week broke through to an all-time high:

chart of the Dow Jones Industrial Average
Click here to enlarge

Source: Google Finance

As you can see from the chart, the Dow muddled around in about a 10% trading range for a year…before eventually breaking out higher.

It meant that investors in the US faced the same problem that Aussie investors face now. Do you stick with stocks that may not grow any further, and which pay dividends that may not grow either? Or do you sell and get next to nothing in a low-risk but low paying bank account?

Here’s our advice…

Our Two Favourite Assets for 2013

For the past couple of years we’ve tried to keep things fairly simple.

We told you to buy dividend-paying shares to get better-than-the-bank income. That strategy paid off…although not in the way we expected. We didn’t bank on boring old dividend-payers rocketing up 30% or 40% in just a few months.

We tipped income stocks because we expected them to be stable and offer a stable income.

That’s why at the lunch yesterday there was some caution about the outlook for these types of shares.

But if you’ve followed all my advice you won’t just own dividend shares. By now you should have your assets nicely spread across a few asset classes (eg. Gold, cash, dividend shares, small-caps).

The next trick is to work out where you’ll put your incoming cash flow to work. You’ll need to decide which of those assets you believe will perform best over the coming months.

Until recently, we thought gold was the best bet, but we’re having second thoughts. We’ve even held off on an expected gold purchase. Instead, we’re looking at two other asset classes for the short term – dividend stocks and small-caps stocks.

Small-caps are obvious. The stock market has beaten them to a pulp over the past year, but we’re so convinced that the time is right to buy small-cap stocks that we’ve hired a research analyst (Sam) to help us scour the market for quality (and speculative) small-cap stocks.

You’ll hear from Sam and get to see some of his analysis later in the week.

The other asset class – dividend stocks – may not seem so obvious. That’s especially so if you look at the big run up these stocks have had recently…

Keep a Look Out for ‘Cheaper’ Shares

But if we look at the Dow Jones index as a template for what can happen after a big run, it’s plain to see that the Australian share market could follow the same pattern.

That is, after reaching or getting near a key level (in the Aussie market’s case, 5,000 points), investors will take a break. As we mentioned above, investors find it emotionally hard to buy shares when they’re trading at the top of a trend.

But after stocks have traded at or around a certain level for some time, investors can get used to it. And importantly, they start taking more notice of the fundamentals. They’re looking for an excuse to either buy or sell shares.

The US market suffered this fate for a year. Stocks traded in a range until investors had an excuse to buy and push prices even higher. The catalyst in the US market (aside from money printing) was higher company profits.

Today, it appears that investors feel that this is as much as they’ll pay for stocks based on current earnings and dividend levels. Or that’s how we’re reading the recent spate of volatility.

In short, while we’re still bullish on the stock market, it always makes sense to revisit your investing gameplan. Right now, we wouldn’t be surprised to see stocks wobble either side of 5,000 points for most of the rest of this year.

That should give you plenty of chances to put some of your free cash flow to work by buying dividend stocks as they slip to ‘cheaper’ levels.

Just remember, don’t invest all your cash. You still need a big cash buffer (20% minimum is our tip), but the next ten months could give you the perfect chance to grab stock market volatility by the scruff of the neck and get it to work for you rather than against you.

Cheers,
Kris

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From the Port Phillip Publishing Library

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Money Morning: Why the Dow Jones Record High Doesn’t Matter

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Australian Small-Cap Investigator: Why Invest in Small-Cap Stocks? And Why Now?

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