Some Words of Wisdom

With the passing of Martin Zweig, Wall Street lost one of the most successful investors in history. But thankfully, good ideas rarely die with their creators, and Zweig had a lot of good ideas that investors can learn from today.

Many tributes to him recalled his memorable appearance on Wall Street Week with Louis Rukeyser on October 16, 1987, where he warned of a stock market crash.

It happened the very next trading day, and Zweig’s reputation as a forecaster was sealed.

Still, that understates his importance. A numbers wizard (he got a PhD in finance from Michigan State), Zweig saw patterns in the market no one else could. His newsletter, The Zweig Forecast, had a stellar track record.

He also had a simple philosophy that can help ordinary investors navigate even the most treacherous markets. By sticking to it, investors can participate in the upside while limiting downside risk. Many people claim to have done that, but Zweig actually did.

Zweig’s nostrums are well known—“Don’t fight the Fed,” “don’t fight the tape”—but they shouldn’t be taken for granted. Used correctly, they’re a recipe for making money and reducing risk.

"Don't Fight the Fed"

“Monetary conditions exert an enormous influence on stock prices,” he wrote in his book Winning on Wall Street. “Indeed, the monetary climate—primarily the trend in interest rates and Federal Reserve policy—is the dominant factor in determining the stock market’s major direction.”

“Generally a rising trend in rates is bearish for stocks; a falling trend is bullish,” he continued.

Why? For two reasons. “First, falling interest rates reduce the competition on stocks from other investments, especially short-term instruments such as Treasury bills, certificates of deposit, or money market funds,” he wrote.

“Second, when interest rates fall, it costs corporations less to borrow. As expenses fall, profits rise...So, as interest rates drop, investors tend to bid prices higher, partly on the expectation of better earnings.”

Isn’t that exactly what’s happening now? After resisting for years while the Fed drove real short-term interest rates below zero, investors have jumped back into US stock mutual funds and ETFs.

And companies have zealously controlled their expenses and have refinanced every bit of debt they could at rock-bottom rates. No wonder corporate profits are at their highest percentage of GDP in more than 60 years.

“Don’t Fight the Tape”

“Big money is made in the stock market by being on the right side of the major moves,” he wrote.

“The idea is to get in harmony with the market. It’s suicidal to fight trends. They have a higher probability of continuing than not...Strong momentum tends to persist...Fighting the tape is an open invitation to disaster.”

Zweig advised investors not to go all in or out, but to keep a position in stocks and increase it when the risk was low, while reducing it when the risk was high. “What you are concerned with is the probability of success or, alternatively, the probability of losing money. You want to avoid loss. So, it’s fine to buy above the bottom and to sell below the top,” he wrote.

How do we know if we’re near a top? Start with the Fed, of course. When rates are low, as they are now, the second of two rate hikes or a one-percentage-point increase in the prime rate would trigger a Zweig sell signal.

Would the end of “quantitative easing” constitute a rate hike? Good question, but I doubt it. That means we probably don’t have to worry about a monetary sell signal until at least 2014.
Zweig found that every bear market from 1919 to 1982 had at least one of three conditions:

• Extreme deflation
• “Ultrahigh” price-to-earnings ratios in the upper teens and twenties
• Or an inverted yield curve, where short-term interest rates exceed long-term rates

Seen any of those lately? No.

We live in confusing times—slow economic growth, the aftermath of a major financial crisis, ballooning national debt, and the loosest monetary policy the Fed has ever pursued. But that loose policy has staved off deflation and the inverted yield curve that often precedes recessions—two of Zweig’s critical indicators for bear markets.

Source:  Howard Gold, MoneyShow.com

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