INVESTING: Market’s ‘gas light’ is on; when will it finally hit empty?

One of the nice things about modern car design is the gas light. You start running low, a light pops on to tell you to fill up. Ignoring this light can prove a little dangerous. As you get closer to empty, you know the car can keep going, but you don’t know for how long. And you don’t know where you will be when it runs out.

The stock market acts a lot like your car, with one major difference. The market can keep going with very little gas in the tank. Typically, most investors don’t know where they are going to be when it runs out. But the major difference is the stock market doesn’t have a gas light. There are signs if you know where to look, but most participants are looking for a light. And by the time it goes on, it is way too late.

The stock market is not exactly running on fumes right now, but the light just went on. I have been recommending caution for a while now, and I have received some criticism for my stance. To which I reply, I let the market dictate my actions, and in the last few months the risks associated with being long in stocks have outweighed the rewards.

The evidence continues to increase showing investors are more and more likely to take profits, and less and less willing to commit new capital to stocks. This is a combination leading to some form of correction. Perhaps that’s why the S&P 500 hit 1295 on Jan. 11, and is at 1285 today. A lot of noise, a lot of effort, with nothing to show for it.

With perhaps a gallon or two left in the tank, the best strategy is to hold only stocks with the highest relative-strength ratings. These stocks should be demonstrating no signs of negative divergences between their relative-strength rankings and the recent price moves.

Don’t commit new capital to the market right now. This is a high-risk time to be buying new stuff. This is also an ideal time to identify stocks that have not kept pace with the market since the October 2005 rally began. These stocks should be quickly sold. At this stage of the bull market, stocks that haven’t joined the party probably won’t, and odds are they will lead on the downside, with possibly devastating results.

Now that the first-quarter earnings season is in full swing, look back three months to see what can happen to stocks that miss earnings this late in a bull market. Apple and Google both were hammered, losing almost 30 percent over the next few months. General Electric announced earnings this month, and they looked good. No matter. Investors gave the stock a quick 5-percent haircut.

People always are trying to attach meaning to actions. A typical headline might be, “Stocks fell today because of tensions in Iran.” I spend a lot more time on the actions than I do the reasons. But maybe oil at $70 a barrel, gold at more than $600 an ounce, and the yield on the 10-year bond at more than 5 percent are all reasons investors are losing their appetite.

It could be something else entirely, like the slight problem Washington has keeping within budget. We will find out about a year from now. Today, it’s enough for me to see the gas light on.