When you pull back the camera and take a bird’s eye view, you can see that, so far, corporate earnings have been pretty unspectacular. Only 60% of the S&P 500 have beaten expectations, 28% have missed, and the balance have just met lowered estimates.
Most importantly: The rate of earnings growth is slowing, not increasing. For all of 2011, S&P 500 earnings grew at 7.5%. But, if you pull out the two top earnings outliers (Apple Computer and, believe it or not, AIG), actual earnings growth was below 2%.
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Earnings growth has slid from 18.25% in Q3 2011 to a paltry 5.59% in Q4 2011. In fact, this is the weakest start to earnings season since the darkest of dark days during the 2008 recession.
By buying stocks right here, right now, you are making a straight up bet that earnings growth is going to ramp up, and ramp up quickly.
And that is exactly what Wall Street thinks. Everyone is ratcheting up earnings expectations, on the heels of much improved economic news. So far we’ve seen an excellent employment report, better manufacturing data, and improving consumer confidence numbers.
But what if Wall Street is wrong?
If we’ve learned anything since the great bull market that started in 1982 and ended in 2000, it’s that Wall Street’s predictive powers are rubbish. They really are not very good at modeling the future.
Anybody can make money by buying the dips during a bull market, and that’s exactly what Wall Street did for 19 years. It worked, because the great bull market masked the general incompetence of Wall Street. Even a blind squirrel can find a nut every now and then, and a 19-year bull market allowed a lot of blind squirrels to look like nut finding Oracles.
The point I am trying to make here is that even if earnings continue to improve, buying stocks right here, right now might not be the best entry method to employ. By buying right now, you are making a black and white bet that we will see no negative surprises in either earnings or headline risk (Europe, Iran etc.).
Now, we may very well be at the beginning of a brand new leg of economic growth, but you have to ask yourself: Do you want to make that bet at the top of the trading range or at the bottom of the trading range?
Speaking for myself, I’d much rather rely on history, which tells me that even in the greatest of bull markets, big scary pullbacks occur. It is on these pull backs that you can get long (buy) at the bottom of the trading range rather than at the top.
A quick and easy method I use to buy stocks on pullbacks is to use moving averages. I normally use the 20 day moving average, the 50 day moving average, and the 200 day moving average. Any free chart site will offer these tools for you.
On a mild pull back, most stocks will pull back to their 20 day moving average. On a more severe pull back you will see the 50 day come into play. On a serious pull back you’ll see stocks start to hit their 200 day moving average.
Using this approach, along with a long term trend indicator such as the New York Stock Exchange Bullish Percent (NYSE BP) as a trend confirmation tool, you can really take advantage of deep sell offs to scoop up some great names on the cheap.
The key is to make sure that your long term trend indicator is still bullish. If it is, then you can feel free to buy in on the pull back.
We saw similar action occur in early 2009. The market streaked higher, then fell apart, but unlike 2008 our primary trend indicator stayed bullish, indicating to us that it was safe to buy the pullback.
The 20, 50 and 200 day moving averages were invaluable trade entry tools during this tumultuous period.
Tags: 19 Years, Aig, Apple Computer, Blind Squirrel, Buying Stocks, Confidence Numbers, Consumer Confidence, Corporate Earnings, Dark Days, Dips, Earnings Growth, Earnings Season, Economic News, Employment Report, Eye View, Incompetence, Oracles, Squirrels, Term Trend, Trend Indicator
