In recent months, commodities have risen substantially across the board, with everything from silver to soybeans posting dramatic gains. What has received the most attention, for obvious reasons, has been the rise in crude oil. Higher crude means higher gasoline prices at the pump. We’re a nation of drivers. Gasoline is one commodity most of us buy regularly.

Not surprisingly, politicians and journalists have all weighed in on how to deal with the “high” cost of gasoline. Thankfully, they’re not managing your portfolio. Because from a trader’s perspective, thinking of markets as “high” or “low” is a linguistic trap that should be avoided.

As I often point out, a real bull market is built on doubt. And when you get right down to it, nothing is more doubtful than describing a market as being high. There’s a quiet, condescending, passive-aggressiveness about it that seems to suggest that the real move has already been made. After all, if investing is about buying low and selling high, who in their right mind would buy high?

Take technology stocks. Although it now seems like ancient history, I can very clearly remember the Nasdaq’s relentless climb throughout the mid and late 1990s. When you get right down to it, Cisco (CSCO), Microsoft (MSFT), Sun Microsystems (SUNW) and all the other leading stocks were “high” for years on end. As it turned out, there was big money to be made on “overvalued” stocks that were way too “high” to buy.

And that’s one of the problems with describing a market as “high.” Just because a market has risen dramatically doesn’t mean it can’t continue to do so. In fact, at any given moment, an established market trend is far more likely to persist than to reverse itself. In a bull market, trends tend to last longer than most people believe.

So although $35 a barrel for crude might feel high, we might eventually consider the price to be rather modest should the rally in commodities continue, as I believe it will. Just as Nasdaq at 1500 felt high in 1997 after trading 30% lower just a year earlier, crude oil at current prices might one day be perceived at cheap should prices rise to $45 or $50 a barrel. Sound far-fetched? So did Nasdaq 5000 back in 1998 when the index was under 2000 and everybody was sure the real upside potential had already passed.

One of the more fundamentally compelling arguments for a continued rise in energy prices is that, adjusted for inflation, they are actually rather cheap. According to the Lundberg Survey, the average cost of a gallon of gas is now $1.80, which is only about 40% higher than the $1.28 we paid back in 1983. Had prices simply kept pace with inflation, gas at the pump would now be $2.80 or higher. And to all of the collectivists who believe the government should (further) regulate oil prices, it’s worth noting that the price of a first-class stamp has gone from 20 to 37 cents during the same period, a jump of 85%.

From a trader’s perspective, however, the real significant indicator that energy prices aren’t as high as we believe is the fact the entire asset class remains unquestionably strong, with many other commodities at multidecade highs. Soybean prices have more than doubled since 2002. Corn prices are up by more than a third over the same period. Pork bellies are at all-time highs. And gold isn’t too far from a 15-year peak.

I don’t think in terms of high and low, but rather strong and weak. Strong investments are those quiet but consistently rising securities that lead the pack even when they don’t make the headlines. And when the entire group looks equally strong, it’s even more of a bullish confirmation that a solid trend is in place.

Nobody knows the future, but in my experience, the biggest advantage you can have in the markets is trading with the trend. Not fighting the market, but following it. And although energy prices might feel high, they’re historically cheap when adjusted for inflation.

Moreover, when looking at commodities as an asset class, one can’t help but take note of the across-the-board strength. Big moves take time. I’m positioned as if the hard-asset boom still has room to run.

– Originally on Apr 05, 2004 by Jonathan Hoenig

These days, the rising tide continues to be in bonds and other income-oriented instruments. We’ve been talking about bonds for quite a long time here, most recently in January. Although I admit that I’ve been repeating myself on this issue, I also know that this is the nature of bull markets: They move in trends, and trends often last a lot longer than most people expect.

The rise in bonds, and their continued outperformance relative to stocks, has been so dramatic that many market players are speculating that we’re in the midst of a bubble. But from my perspective, it’s not a bubble at all. It’s simply a bull market.

As we’ve been emphasizing for years, a big part of successful trading is avoiding the herd. And while bonds have exhibited strong price performance, I’ve yet to see any real evidence that the herd is running into fixed income.

First off, let’s remember that strong price performance doesn’t necessarily indicate big changes in herd mentality. Ask most people about bonds these days, and they’ll chalk up the strong performance to “safe haven” buying. Indeed, even on supposedly sophisticated business television, you hear the same shockingly ignorant analysis: that bonds are rallying simply because investors are scared and are seeking safety.

But as we pointed out last summer, many commentators are often quick to inaccurately interpret a market move as the result of some action of investors. The truth is, it can also be their inaction that’s ultimately responsible. Remember: The law of supply and demand is also the law of demand and supply. Often it’s not the presence of buying, but the absence of selling, that can make a market move higher.

The fact is, bonds are strong. Is it war fears? The slowing economy? Hedge funds caught short? Who knows. The point isn’t to understand why bonds are outperforming, but simply to know that they are outperforming. So instead of discounting the market’s strength, let’s study it.

A classic characteristic of a bubble is an explosion in both volume and public participation. One way to get a fix on both is to examine the activity in exchange-traded funds, the now ubiquitous mutual funds geared toward aggressive retail investors.

Just take a cursory look at the trading volume of the iShares bond ETFs. I first wrote about these products just after their launch last year, and I followed up by naming them as one of my “favorite things” last December. One indication that there’s no major bubble or public participation in these instruments is that despite continued price outperformance, their volumes remain well below that of your average midcap stock.

Indeed, if there’s irrational exuberance in bonds, you certainly aren’t seeing it show up in the fixed-income version of the QQQs (QQQ). According to Yahoo! Finance, the iShares Trust Lehman 20+ Year fund (TLT), which tracks long-term Treasurys, trades approximately 203,000 shares a day. Compare that with the QQQ, which still — even after three years of the worst bear market in history — averages more than 68 million shares a day.

Volume is one telling sign, public sentiment another. As painful as it might be on this anniversary of the Nasdaq’s all-time high, think back to the euphoria surrounding tech stocks in late 1999 and early 2000. The prevailing attitude at that time wasn’t fear, but greed. From cabbies to CEOs, people weren’t just talking about tech stocks — they were buying them by the truckload. Technology mutual funds couldn’t be opened fast enough, and Cisco (CSCO) became a household word. The returns weren’t just handsome — they were grotesque. In 1998, Amazon.com (AMZN) was up 966%, CMGI (CMGI) was up 605% and AOL (now AOL Time Warner (AOL)) was up 585%.

And this is precisely why I’m still betting on bonds. In the early stages of a real bull market, the prevailing attitude isn’t greed or even fear, but doubt. Gains are viewed as temporary events, chalked up as short covering, program trading, war fears…just about anything but the start of a legitimate bull run. And while the returns on bonds have been strong, they haven’t yet reached the mania stage implicit in an unsustainably speculative boom.

As we always like to point out, there’s never a substitute for proper trading technique. But when it comes to security selection, all signs are telling me that right now, the real bull market is still in bonds. And if the history of Nasdaq 5000 is any guide, this isn’t a bubble, but just the beginning.

– Originally on Mar 10, 2003 by Jonathan Hoenig

Like my well-pedigreed colleagues, I too have a price at which I’d like to buy Cisco: $81.82 a share. In fact, I would love Cisco at $81.82, its all-time high. I’d adore it. I’d be all over it.

Seem strange? Perhaps. After all, if Cisco ever got back up to the high it reached last March, plenty of people — especially those sitting on losing positions — would sell, anxious to recoup their losses or protect profits before the stock took another dive. It’s what I hear when I talk to prospective clients about reallocating some of their assets away from tech. Everyone is waiting for a bounce.

That thinking is understandable, but flawed: The truth is that if the stock ever did rebound back to its old highs, it would be a signal to increase, not decrease, your exposure. It’s a question of timing, and from baseball cards to Brocade Communications (BRCD), trading is all in the timing.

“Timing the market” is usually shorthand for buying XYZ after it’s plunged and hoping it immediately darts higher from that moment forth. The word for that isn’t timing, but delusion. True market timing isn’t a flawless passport to profit, but an intuitive and logical way to approach allocating your assets. This week I’ll discuss timing in the market; next week, in your individual portfolio.

Among financial planners, market timing might as well be a four-letter word. They argue that it’s a dangerous and fruitless endeavor, that the prudent and wise investor simply buys solid companies when they’re cheap (read: weak) and holds onto them for the long term. And maybe that worked back in the 1950s when the market yielded 5% in dividends and traded at 10 times earnings. It’s hard to make the same argument, however, with stocks like Cisco, which, despite its breathtaking fall, is still trading at a hefty premium to the market while paying no dividend.

Because you aren’t getting paid to hold a stock, you’ve got to get paid through capital appreciation. Not just buying XYZ, but buying and selling XYZ at the right time. As I’ve written before, what moves Cisco, JDS Uniphase (JDSU) or any other stock higher is the liquidity situation for the company’s shares. Stocks go up because there’s more demand than supply at current prices, and that means there is, in fact, a “good” time to get in to or out of XYZ.

Regular readers know that I often talk about “listening” to the market. Simply put, this means that I am bullish on XYZ when the stock gives me reason to be bullish, not the analysts, the news or the latest talking head. Conversely, when XYZ falls from $100 to $25, chances are that it isn’t because the stock is taking a breather on its way up to $300. A weak stock is weak for a reason. It doesn’t always mean we know what the reason is, nor does it even matter what the reason is: The point is that the stock is moving.

Stocks aren’t chaotic, and although it might seem like it, the Nasdaq didn’t move from 5000 to 2000 in a day. The markets move as the seasons do, in observable and traceable trends. In short, there’s a method to the madness. Let’s say you were shipwrecked, “Cast Away”-style, on a remote island without any access to the outside world. Even if you didn’t have a calendar, you would, after a time, get a sense of what season it was. You’d observe the slightly shorter amounts of sunlight or cooler temperatures. You’d watch the birds fly south for the winter. And while you might not be able to nail the exact day, eventually you’d begin to realize that summer was becoming fall. The colder and darker it got, the more evidence you’d have that, in fact, winter was coming. Prediction from observation. It’s a guess…but not a gamble.

The same logic applies to the markets. It’s called persistence of trend. A stock that has been strong for a period of time will tend to remain strong. Likewise, while there’s no guarantee, weak stocks tend to remain weak.

So no matter what timeframe you are trading in, as a rule of thumb, the best time to buy a stock is when it’s strong. Keep in mind that “strong” refers to a stock’s price action. It’s got nothing to do with the news, economic fundamentals or comments from the peanut gallery.

How do you know if a stock is strong? One of the easiest and most intuitive ways is to wait until it trades above a previous multiperiod high. I specify multiperiod because buying “the breakout” is a technique that can be utilized within all trading timeframes.

While scared money might cringe at buying the top, if a stock is revisiting a historical high — especially a long-term historical high — it’s a reason for bullishness. Combined with good position size and order-placement technique, it’s an ideal way to get in at the best possible time.

Consider this: In February of 1973, IBM (IBM) traded at a split-adjusted price of $23 a share, just as equities began the worst bear market in history. And although you could have picked up Big Blue at the “bargain” price of $13 a share just one year later, it wouldn’t have done you much good. As late as 1981, some eight years later, the stock still traded at a fraction of its early 1970s high. Some bargain!

The best, or at least the safest strategy, would have been to buy IBM as soon as it eclipsed its pre-bear-market high of $23, in December 1983. And while we can be certain investors were frightened buying the stock as it hit those 10-year highs, it proved an opportune moment to get in. IBM marched on to a 100% gain from those seemingly lofty levels.

What was the signal to buy IBM? It wasn’t an analyst, or an overwhelmingly positive bit of corporate news, but the stock itself. When IBM was able to break out from the decade-long trading range, the stock was, in effect, “telling” us that it was ready to move even higher. Value-oriented fundamentalists hate this sort of analysis because it ignores all the actual economics going on within a company. Buy a stock when it’s cheap, they cry, and wait around for the market to realize its error. Alas, those who’ve bought the dips on stocks like Cisco over the years have now come to realize that while markets are never wrong, opinions often are. When a stock is dropping, let it drop. It isn’t your constitutional duty to stand between Cisco Systems and a new 52-week low.

To that end, those wishing to play Cisco from the long side might develop a trading plan more detailed than “buy and hope.” To start off, wait for some strength. With ammo in short supply, you’ve only got a limited number of bullets. The price action should get bullish before you do. If the trade moves your way, stick with it. As long as you use proper diversification and risk-management techniques, you’ll want to follow the trend, not fight it.

Past performance is no guarantee of future results, of course, but it’s a pretty effective indicator. Buying the breakout isn’t foolproof, and just because a stock makes multiperiod highs doesn’t mean it can’t fall just as fast. But generally speaking, you want to buy stocks that are getting up from the mat, not falling down onto it.

To everything there’s a season. And when a stock is about to bloom, it will tell you. But as long as it’s snowing outside or the rain is coming down, stay indoors. The yard will still be there next spring.

– Originally on Aug 09, 2001 by Jonathan Hoenig