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Investors hate it when stocks fall. But at times like this, when the stock market seems to be moving up in nearly a straight line, you may find it even more challenging to make smart investing decisions.
Later in this article, I'll reveal some tips on putting your money to work even when stock prices are soaring. But first, let's take a look at just how big a move we've already seen.
Most investors are aware of the strong start that 2012 has had. But what they may not have noticed is just how smooth a ride up it has been. The S&P 500 hasn't had a drop of 1% or more since Dec. 28, punishing investors who'd gotten used to the "buy on dips" mentality that served them so well in late 2011.
At the same time, many investments have had far more dramatic up-moves than the 9% gain in the S&P since late December. iShares Silver Trust (NYSE: SLV ) is up more than 27%, for example, as precious metals have bounced sharply from their year-end lows after the combination of Greek worries and continuing low interest rates helped reverse a late-year correction that sent prices to their lowest levels in 2011. Similarly, emerging-market ETFs have soared, with Market Vectors Russia (NYSE: RSX ) and iShares MSCI Brazil (NYSE: EWZ ) among the top performers, with roughly 20% gains. Investment analyst Bespoke points out that 94% of ETFs are trading above their 50-day moving averages, suggesting that the markets may have come too far too fast.
Put those two trends together and you end up with a conundrum. We've all been well-conditioned not to chase rising markets, as the threat of buying high and selling low is a big disincentive toward putting money to work. Yet as markets churn ever higher, the fear of missing out on an even bigger bull market is a constant temptation to go ahead and invest. So which impulse is right -- and what's the best way to act on it?
2 things you can do now
As in any investing environment, it's important to take emotions out of the picture when you're thinking about how to handle a raging bull market. The emotions involved are far different from those experienced during a market crash, but they can be just as destructive in taking you away from your long-term investing plan.
Rather than making abrupt moves, I try to do two things when markets are soaring. First, I make a shopping list of stocks that I like but that don't pass my valuation test. That way, if a correction does come -- and it almost always does -- then I'll be ready to pounce.
One example is Chipotle Mexican Grill (NYSE: CMG ) . Unlike other high-momentum stocks, Chipotle's shares have continued to move higher, thwarting short-sellers and their calls for an inevitable correction. Yet even with estimates calling for 20+% long-term growth, its current valuation of more than 35 times 2013 earnings projections is too rich for my blood.
By doing research on Chipotle now, I can figure out what price I would be willing to pay for the stock. I may never get the opportunity if the stock price doesn't cooperate. But if it does, I'll be prepared, having done most of the legwork already.
The other thing to consider is looking at sectors that haven't participated in the rally. For instance, recently, natural gas stocks have been hurt by the huge successes in new finds, as a glut of natural gas has brought prices down to decade lows, and low-cost gas producer Ultra Petroleum (NYSE: UPL ) down to multi-year lows. That by itself doesn't make Ultra a value stock -- but if you believe that gas will eventually recover, then it's worth thinking about putting money to work there now rather than buying stocks that have already gotten bid up.
Whether you're in a bull, bear, or flat market, the key to smart investing is having a plan. If you know what you'll do next before you see exactly how the markets play out, you'll have a big edge over your fellow investors -- and you'll be able to use that edge to profit where others miss out.
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