Understand the Opportunity and Make Sure You're Positioned for It

Investor psychology has almost never been more negative than it is right now. Counterintuitively, that is a huge positive for future market action. Last week's reading from Investors Intelligence, published prior to the latest major selloff, registered as low as it did near the best historical buying opportunities since the Crash of 1987: the Financial Crisis of 2008-09, the Christmas Eve Capitulation of 2018 and the Covid-Panic Low of March 2020. Readings like those only come after horrendous downturns that have investors puking up their shares simply to lessen the pain of seeing their stocks become less valuable almost every day. Last week's AAII sentiment survey was also quite notable. As with the chart above the data was tabulated before the latest plunge from Friday April 22 through Tuesday April 26. AAII's weekly sentiment surveys have been published ever since 1987. In around 45 years there were only 33 times that overall bullishness fell to under 20%. Last week marked the first time since mid-May of 2016 that phenomenon occurred in consecutive weeks. The converse of low bullishness has proven to be a reliable sell signal. Market peaks pre-crash 1987 -- during the first quarter of 2003, the entire first half of 2007, most of 2013-2014, late 2017 and during November and December of 2021 -- all gave traders chances to lighten up at overpriced valuations. Unless you disbelieve history, the stage is now set for a monster rally, which could begin quite soon. Could we really have predicted that even stalwarts such as Apple should have been sold late last year? Absolutely. Here are some graphics on why that was obvious last December. The next graphic showed that, with AAPL at $175.74, its P/E was more than twice its historically normal level while its yield was 72% below what had been paid from 2011 through 2021. Value Line still called it top-rated for both timeliness and safety despite their own 2024-2026 projected price ranges showing little to no upside. How crazy was that? But Value Line was not alone in touting AAPL at an extremely extended valuation. Barron's ran the following story last December telling people that this time is different while advising people to buy at all-time highs because the stock was certainly only going higher. Knowing what a stock is worth becomes essential information in filtering out bad input from media sources. I always go by the same stock's own historical valuations versus the current ones. That's because it removes opinion from the equation by using actual prior data to assess where a stock should trade. On Dec. 10, 2021, AAPL's P/E of 32 was by far the most extreme on the entire page. Its yield was the lowest in more than a full decade. Price-to-book value and price-to-cash flow metrics were equally extravagant. Paying more than everyone else for exactly the same merchandise is never a good strategy if you want to resell that item later for a profit. That is equally true for cars, real estate and equities. I conservatively assumed AAPL would at least revert to a more pedestrian, though higher-than-average P/E over the coming year. That resulted in a 12-month target price of $123. Why then, should anyone have been happily paying almost $180? Apple briefly ran to $182.94 before faltering. As of March 14, 2022, AAPL had regressed to as low as $150.10. The FY 2011 to FY 2021 growth table below explained why Apple was vulnerable. The firm's progress was terrific but its share price run-up was widely disproportional to the growth in fundamentals. That can only come via P/E expansion. Buying shares after a major increase in valuation is usually a recipe for disaster. Anybody with an understanding of that concept could see that APPL offered puny, or even negative returns going forward. Yahoo Finance set a 12-month goal price of $170.78 which was below the quote at that moment. That appeared over optimistic to me as it assumed APPL could hold at almost 30x forward earnings versus a 14.6x normalized multiple. Even if you believed it could do that there was no reason to buy/hold Apple near $180. Research house Morningstar was less generous, and more realistic in its evaluation of Apple at $179.45. It called the shares as a 2-star, out of 5, sell. Morningstar's present-day fair value for AAPL last December was almost exactly in line with my own, at $124 per share. Other big tech shares like Microsoft were similarly overvalued, leading up to 2022's big YTD 2022 declines. Work their numbers and you'll find they are still very pricey. If the market is ready to rumble, as psychological data suggest, the best way to benefit is through ownership of companies which are historically cheap versus their own normalized metrics. They can surge as P/E expansion kicks in again, rather than suffering from P/E contraction. Many fine stocks are heavily discounted and poised for huge rebounds. The Law of Asymmetric Returns has not been repealed. Buying in after large percentage declines can produce life-changing gains, often in very short time periods. See my recent articles on stocks I favor to get some ideas about where to put your money to work in this environment. (AAPL and MSFT is a holding in the Action Alerts PLUS member club. Want to be alerted before AAP buys or sells these stocks? Learn more now.)

Understand the Opportunity and Make Sure You're Positioned for It

Buying in after large percentage declines can produce life-changing gains, often in very short time periods.

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