The Opportunity Cost Of NOT Being Invested In The Stockmarket

In last month's newsletter when the FTSE 100 was around 6100 I wrote an article suggesting the stockmarket might not be working correctly.

This was because a stockmarket is supposed to be a forward pricing mechanism. Therefore in my eyes, because of the current economic mess, I believe stock prices should be a lot lower, anywhere between 500 and 1000 points.

One important point to bear in mind with this article is that I'm talking about the general stockmarket and not about any specific stocks. This means if I like a certain stock (such as Mining stocks or Spurs, discussed on the following page) I will continue to buy regardless of what the overall market is doing, or is likely to do.

An Interesting Rally Develops

As soon as last month's newsletter was published stock prices enjoyed a 2-3 day rally pushing prices up to around 6375 (FTSE 100) before coming back down just as fast to stand right now around 6100.

What was the reason for this punchy rally? I think it all had to do with another set of deeply massaged US economic figures (from memory they were GDP). Now only a fool or fanatical patriot believes anything the US government publishes when it come to economic figures these days but then only another fool would bet against perception.

Yes, perception over reality normally wins in the markets. When those GDP figures were released (whether anyone believed them or not) the market's perception was that they were good and the bad times were over - therefore the bumper 3-4 day rally.

Now I don't believe for one minute that serious market participants with any clout are under any illusion that the stockmarket is a house of cards and an accident waiting to happen. But again, as long as the perception is neutral/mildly bullish they'll stop from taking any action.

But if this perception breaks down then a whole wave of selling will break out forcing more sell orders leading to far lower stock prices. This is what I think is coming, but as ever the timing of such an event is the million dollar question.

Credit Crunch Leads To Household Crunch

The reasoning behind my bearish view is the credit crunch is likely to morph into the household crunch because most of the population seems financially tapped out.

Almost every necessity that we buy has shot up in price and if you add this to the personal debt problem here in the UK (and US) I think that the average citizen must be in trouble. Well, perhaps not all are in financial trouble but the days of throwing money around and racking up our huge amounts on credit cards must be over.

So if the general population is struggling with their personal budgets just where is the profit growth going to come from? And if there's no general rise in UK PLC profits the stockmarket is going to find it hard to move higher.

8% - 12% Seems The Maximum Possible Rise In 2008

The FTSE 100 closed at 6425 at the end of 2007 so right now we're down about 5%. The question to ask though is that IF the market were to rise in 2008 how much would that rise likely be?

I would say a gain of between 8%-12% is the maximum. Yes, strange moves can always happen in the markets but in the current economic climate I think that England have more of a chance of winning the European Football Championship in Austria/Switzerland this summer (and they're not even in the competition) than the stockmarket rising by more than 12%.

Beware The Old FTSE 100 Highs of 6740

However, if the market is to rise in 2008 then I think 5% is a far more sensible figure. This is because +5% from the 2007 close of 6425 puts prices bang up against the 5 year bull market high (beginning in 2003) of around 6740 (summer of 2007) and such an important level has to be odds-on for major resistance.

Normally what will happen around these major levels is prices push and then rebound, push and then rebound without going anywhere over a 2-3 monthly period. The diagram below illustrates this.

What's The Opportunity Cost By Staying In Cash

Right now with about 10 minutes of shopping around anyone can easily get 6.5% on their cash. In fact, recently there have been some 6 month and 1 year fixed bonds offering around 7%. All of these products, assuming you deposit less than the guaranteed amount of £35,000, have zero downside.

Now take 6.5% and add it to last year's FTSE 100 closing 6425 and you get 6840 which is 100 points higher than the 5 year bull market stockmarket high.

So to me being in cash is a far better alternative to being invested in the general stockmarket. Not only is there a reasonably good yield to be earned (yes, of course inflation has to be considered) but cash has the added advantage of offering investors options should the markets slump in the final 7 months of this year.

Summary

As I said in last month's newsletter cash right now is a hard asset class to beat because it holds two distinct advantages over being invested in the general stockmarket.

1. From a psychological point of view if the market declines we won't get depressed because little or no money will have been lost. This should mean we'll be able to analyse potential investments with a clear and rational mind.

2. If the markets do get hit most stocks will take a beating. So cash buyers who have done their research into certain stocks or sectors should find some excellent bargains on offer.

For example, I still like the potential of Gold over the next several years, expecting it to go to $1,650 or higher. But if a wave of selling hits the general stockmarket Mining stocks will not escape the rout. So those with cash and a long-term view built on solid fundamentals should again be able to find some good bargains.

However, if the market rises over 2008 it's unlikely I think to do so by more than 5% because it will likely get stuck around the 5 year bull market highs of 6740. But don't forget 6740 is about 10% higher than where the FTSE 100 is trading right now (6100).

Postscript - Why Plan B Is Important

Predictions are dangerous for one simple reason - you can get blinded by them. Right now I'm obviously bearish but am trying hard not to get mentally married to this view. Anything can happen in the markets so we must always have a Plan B in case we're wrong.

In next month's newsletter I'll expand my thinking on this point by coming up with a strategy to take advantage of any stockmarket gains over the coming year.

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