Forget the market; just pick stocks

By Jim Jubak

Is the bear market over? You could make a strong case that it will be if the Standard & Poor's 500 Index ($INX) climbs over 935, the January high. That would break a string of lower highs that characterizes a bear market.

Or is this the stock market just setting up investors for another correction or even another bear market low? The stock market isn't exactly racing to a new high, and indicators say it's overextended and ready for a correction. It's not a good sign that on May 7 the market sold off on the good news that the stress tests wouldn't require banks to raise huge amounts of new capital. It sure looked like a bout of profit-taking.

So what do you do? You sure don't want to miss the rally -- if it's real -- and you sure don't want to buy in at a high if it's not.

My advice: Stop trying to figure out the direction of the stock market, and worry more about the value of individual stocks. Unless you're a pure index investor, you'll be buying individual stocks rather than the market as a whole anyway. So turn instead to the good old-fashioned exercise of calculating target prices. Thinking about this as a market of stocks, rather than about the stock market, will focus you on what's really important: the trade-off between risk and reward.

Let me set up the stock market problem facing investors now and then show you how target prices can help solve it for individual stocks.

Since its low at 677 on March 9, the S&P 500 has climbed closer to the magic 935 number. The index closed at 929 on May 8. That's a 37% gain from the March 9 low and just 6 points shy of where it was Jan. 6.

Why would that be important? Because bear markets don't sketch out a steady pattern of lower and lower prices. They're punctuated by major rallies, such as the one that began at the Nov. 20 low of 752 and then failed at 935 in January. But in a bear market each rally does fail and then -- and this is the defining characteristic of a bear market -- stocks fall to a low that's even lower than the one before.

Spotting the elusive bull

A rally that broke through the January high at 935 would disrupt that pattern and give investors confidence that the next time the stock market retreated, it would end that correction above the March 9 low. That combination of a higher high and a higher low would mean that the bear market had indeed ended and that stocks had moved into another bull market.

Bull markets don't move steadily in one direction any more than bear markets do. That's one of the reasons the current period is so hard to read. We could break over 935, a strong signal that the bear might be over, and still get what's called a retracement of about 33%. In fact, a correction of that magnitude would be typical of the kind of retreat that markets show after a 37% run-up in about 40 trading days.

Pay attention, though, to the word retracement. I'm not talking about a move to 950 on the S&P and then a decline of 33%. That would take us back to 636 on the index, well under the March low of 667. The bear market would still be in control.

A 33% retracement, on the other hand, would mean the index had given back 33% of the gains it had made during the rally. A move to 950 followed by a retracement of 33% would take the index back 93 points, to 857 (93 would represent 33% of the 283-point gain from March's low). That would still leave the market well above the March 9 low. A more severe retracement of 62%, also a common reaction to a big, fast move upward, would still take the market down just 175 points, to about 775, still well above the March low.

In these two cases, we're talking about a 10% or an 18% decline from 950 on the S&P.

If that decline ended there, the bear would be dead, and we could look forward to another bull. But, of course, the retracement could well not stop there and instead turn into another crushing bear market loss. How can you know for sure? Ask me to look back in 2010 or so.

Why it's easier to focus on stocks

Compare the confusion in that scenario with the relative -- and it's only relative, I concede -- clarity you get from calculating a target price on an individual stock.

General Cable (BGC, news, msgs), a stock I've had on my watch list for months (the list is at the end of this column), has had an even more spectacular run than the S&P 500. From its low March 6 to the close May 7, the shares have roared ahead 160%. That makes the 37% gain on the S&P 500 seem paltry.

But what now? Is it time to buy this stock that is so clearly outperforming the market? Time to take profits? To wait for the retracement? To write this off as a ship that's already sailed?

Certainly, this maker of electrical cables has a bright long-term future. General Cable is one of the 50 stocks in my book "The Jubak Picks." Here's what I wrote in 2008: "After years of underinvestment, it's time to start spending on the electrical grid in the United States. U.S. electric companies are projected to spend $14 billion a year over the next 10 years to make up for years of underinvestment. That's actually small change compared to what China, Russia and the rest of the developing world will spend in the next decade to build out their grids."

Continued: Earnings recovery

 1 | 2 | next >